THE LIBRARY OF THE UNIVERSITY OF CALIFORNIA LOS ANGELES SCHOOL OF LAW ES 'sr, CORPORATION PROCEDURE LAW, FINANCE, ACCOUNTING By THOMAS CONYNGTON R. J. BENNETT PAUL W. PINKERTON Edited By HUGH R. CONYNGTON Fourth Printing NEW YORK THE RONALD PRESS COMPANY 1923 T , r ^ COPYRIGHT, 1922, BY THE RONALD PRESS COMPANY All Rights Reserved PREFACE The small businesses of the country are still largely conducted as partnerships or sole proprietorships. Some few of the large businesses are conducted as joint-stock companies or express trusts. The great proportion of the business of the country is, however, conducted under the corporate form, and the corporation is by far the most important form of business organization now in use. The latest available figures show over 320,000 corporations making income tax returns, with invested capital of more than $66,000,000,000. All of these corporations, in their organiza- tion and subsequent corporate existence, are confronted with many problems of procedure. It is the purpose of the present work to furnish in a single volume, an accurate, practical, and conveniently arranged manual that will answer as nearly as possible these constantly arising problems of corporate pro- cedure a work that will give the information so essential in the organization of a corporation that will assist the secretary and other executive officers in its technical conduct after it is organized that will help the corporation treasurer in the solving of his financial problems and outline the accounting procedure that must be followed by the comptroller or other accounting official of the corporation in establishing an effective and ade- quate system of accounts. The book is, in short, intended to meet the practical needs of all those concerned in corporate affairs lawyers, bankers, accountants, corporation officers, and business executives generally. A work embracing so wide a field as "Corporation Pro- cedure," must of necessity require the services of specialists in its preparation. Accordingly the various phases of corpora- tion procedure have been treated by the following authors: iii 667425 iv PREFACE "Corporate Law" by Thomas Conyngton, of the New York Bar, author of "Corporate Organization and Management," "Business Law," and co-author of "Wills, Estates and Trusts." Mr. Conyngton's discussion of the legal and technical problems involved in the organization and management of the corpora- tion has been developed directly from his previous work, "Corp- orate Organization and Management." The treatment is here brought up to date and enlarged by the addition of a detailed discussion of stock without par value, and also of the new form of business organization, closely allied to the corporation, known as the "express trust." The very practical collection of corporation forms which concludes the volume has also been supplied by Mr. Conyngton. "Corporate Finance" is based directly on the very excellent work " Business Finance" by William H. Lough, President of the Business Training Corporation, and formerly Professor of Finance, New York University, School of Commerce, Accounts, and Finance. Mr. Lough is a writer of long experience and standing, and in adapting his material to the requirements of this manual, the original text has been adhered to as closely as the requirements of a co-ordinated and up-to-date treatment would permit. The discussion of "stock rights" appearing in this part of the volume is new, having been supplied by Thomas York, formerly of the staff of The Wall Street Journal, and author of "Foreign Exchange." "Corporate Accounting" by R. J. Bennett and Paul W. Pinkerton. Both Mr. Bennett and Mr. Pinkerton are certified public accountants of wide experience and active practice. Mr. Bennett is a member of the American Institute of Accountants, and also of the Ontario Institute of Chartered Accountants. During the war he was chief accountant in the Division of Audit, State of Pennsylvania, for the United States Food Adminis- tration. He is also author of "Corporation Accounting," "C. P. A. Questions and Answers," "Accounting for Executives," etc. Mr. Pinkerton is an Associate Member of the American PREFACE v Institute of Accountants, manager of the Commercial Depart- ment of Coffield, Sanders and Company, of Indianapolis, and co-author of "Wills, Estates and 'Trusts." The treatment of "Corporate Accounting" is based directly on Mr. Bennett's work "Corporation Accounting," co-ordinated, revised and brought up to date by Mr. Pinkerton and the author. In the discussion of corporate law and general procedure are given principles and also working details as far as can be done in a work intended to be used in every state of the union. It must be remembered that some of these matters are liable to be affected by the continually changing legislative enactments of the different states, which are too voluminous, too divergent, and too unstable to be brought into the present valume. Such variations from general practice must be obtained from the statutes of the particular state. Corporate finance is one of the most important and least understood responsibilities confronting the corporate officials. The aim here has been to give as clear and practical a statement of both principles and procedure as possible, introducing theory only where necessary to explain the usual practice or some divergence .from the usual practice. Many of the matters discussed, as the proportion of fixed and working capital, the requirements and methods of borrowing, the distribution of profits, accumulation of reserves, etc., are general in their nature, applying to any other form of business organization as well as to the corporation. They are, however, so fundamental and so necessary to an understanding of practical corporate finance that they could not be omitted. The presentation of accounting procedure has been based on the best modern practice, and where good practice is not entirely uniform, or not fully established, the different methods are given, the reasons for divergencies are pointed out, and the advantages or disadvantages of the various possible courses are indicated. The concluding portion of the volume containing over vi PREFACE 250 forms used in corporate procedure contributes largely to the usefulness of the book as a whole. These forms have been given for the most part as precedents, i.e., in completed shape, so as to avoid the usual blanks for variable matter. This gives a better idea of the form as a whole. At the same time the changes necessary to adapt the form to any special need are more readily made from the completed instrument than from one broken up by frequent and sometimes puzzling blanks. All those who have assisted in the preparation of "Corporation Procedure" have written before on the same or closely connected subjects, and it is their hope that this result of their combined efforts will meet with the same friendly and appreciative recep- tion that was accorded their respective corporate writings when published as independent volumes. HUGH R. CONYNGTON New York City, May 10, 1922 CONTENTS BOOK I CORPORATE LAW Part I The Corporate Form CHAPTER PAGE I INTRODUCTION 3 II BUSINESS ORGANIZATIONS 7 III ADVANTAGES or THE CORPORATE FORM 13 IV DISADVANTAGES or THE CORPORATE FORM .... 22 Part II Pre-incorporation Considerations V SUBSCRIPTION LISTS AND CONTRACTS ...... 33 VI CONTRACTS PRIOR TO INCORPORATION 42 VII WHERE TO INCORPORATE 50 VIII COST OF INCORPORATION 60 Part III The Stock System IX THE CAPITALIZATION .69 X STOCK 79 XI PREFERRED STOCK 87 XII FULL-PAID STOCK 99 XIII TREASURY STOCK 104 XIV SHARES WITHOUT PAR VALUE 1 1 1 XV NO-PAR VALUE SHARES ADVANTAGES 120 XVI NO-PAR VALUE SHARES PROCEDURE 124 Part IV Corporate Control XVII STOCKHOLDERS 131 XVIII DIRECTORS 147 XIX OFFICERS 157 vii V1U CONTENTS CHAPTER PAGE Part V The Charter XX CHARTER GENERAL CONSIDERATIONS 165 XXI CHARTER INCORPORATORS 172 XXII CHARTER THE CORPORATE NAME 177 XXIII CHARTER THE CORPORATE PURPOSES 182 XXIV CHARTER STOCK; LOCATION AND DURATION . . . 187 XXV CHARTER THE BOARD OF DIRECTORS 192 XXVI CHARTER SPECIAL PROVISIONS 199 XXVII CHARTER EXECUTION AND FILING; AMENDMENT . . 208 Part VI The By-Laws XXVIII BY-LAWS GENERAL CONSIDERATION 215 XXIX BY-LAWS STOCK 222 XXX BY-LAWS STOCKHOLDERS 228 XXXI BY-LAWS THE BOARD OF DIRECTORS 235 XXXII BY-LAWS STANDING COMMITTEES 245 XXXIII BY-LAWS OFFICERS 252 XXXIV BY-LAWS DIVIDENDS AND FINANCE; SUNDRY PRO- VISIONS . . 260 Part VII Organization Meetings XXXV FIRST MEETING OF STOCKHOLDERS . . XXXVI FIRST MEETING OF DIRECTORS . Part VIII Stock Records and Stock Transfer 267 277 XXXVII THE STOCK RECORDS 287 XXXVIII TRANSFER OF STOCK 296 XXXIX TRANSFER OF STOCK (Continued) 302 XL TRANSFER OF STOCK RULES 312 XLI STOCK TRANSFER TAXES; CORPORATE TAXES . . . 327 Part IX Meetings and Records XLII ANNUAL MEETING OF STOCKHOLDERS 335 XLIII SPECIAL MEETINGS OF STOCKHOLDERS 352 XLIV MEETINGS OF DIRECTORS 358 XLV MINUTES OF MEETINGS 3 6 9 CONTENTS IX CHAPTER XLVI XLVII XLVIII XLIX L LI LIT LIII LIV LV LVI LVII LVIII LIX LX LXI LXII LXIII LXIV PAGE Part X The Treasurer I II III IV TREASURER'S DUTIES AND POWERS 377 TREASURER'S RELATION TO OTHER CORPORATE AUTHORITIES 385 TREASURER'S LIABILITIES 393 THE TREASURER'S BOND 401 THE TREASURER'S REPORTS 412 Part XI The Corporate Finances THE CORPORATE FUNDS 415 DIVIDENDS 420 DIVIDENDS (Continued) 431 BONDS 447 BONDS (Continued) 457 Part XII Corporate Arrangements VOTING TRUSTS HOLDING COMPANIES PROTECTION OF MINORITY STOCKHOLDERS INCORPORATING A PARTNERSHD? THE MANAGEMENT OF CLOSE CORPORATIONS CONSOLIDATION, REORGANIZATION AND DISSOLUTION 467 473 483 497 Part XIII Allied Forms of Organization JOINT-STOCK COMPANIES AND PARTNERSHIP ASSOCIA- TIONS 525 EXPRESS TRUSTS AS A FORM OF BUSINESS ORGANIZATION 532 How AN EXPRESS TRUST is ORGANIZED 545 BOOK II-CORPORATE FINANCE Part I The Corporation PRINCIPLES OF FINANCE ORGANIZATION FOR BUSINESS .... THE CORPORATE ORGANIZATION . . . THE CORPORATION IN MODERN COMPANIES , B USINESS ; HOLDING 555 563 573 583 CONTENTS CHAPTER PAGE Part II Corporate Securities V COMMON STOCK 595 VI PREFERRED STOCK 601 VII BONDS 612 VIII SECURED BONDS 624 IX UNSECURED BONDS 634 X SHORT-TERM NOTES 647 XI REDEMPTION OF BONDS SINKING FUNDS 653 Part III The Financial Organization XII CAPITALIZATION BASIS 663 XIII CAPITALIZATION GOOD-WILL, SURPLUS AND INITIAL EXPENSES 676 XIV FIXED AND WORKING CAPITAL 686 XV WORKING CAPITAL REQUIREMENTS TIME, TURNOVER AND TERMS OF PURCHASE 697 XVI WORKING CAPITAL REQUIREMENTS TERMS OF SALE, SPECIAL PROBLEMS 708 XVII THE FINANCIAL PLAN 720 XVIII COMBINATIONS 737 Part IV Securing Capital XIX PROMOTION PREPARATORY WORK 753 XX PROMOTION METHODS OF FINANCING 765 XXI THE PROMOTER 772 XXII PROMOTERS' PROFITS 784 XXIII SOURCES OF CAPITAL FUNDS 791 XXIV SELLING SECURITIES DIRECT To BUSINESS ASSOCIATES 799 XXV SELLING SECURITIES DIRECT To OUTSIDERS . . . 814 XXVI SELLING SECURITIES THROUGH DEALERS; STOCK EX- CHANGE METHODS 823 XXVII UNDERWRITING 837 Part V Internal Financial Management XXVIII BORROWED CAPITAL ' 849 XXIX NET INCOME 867 XXX DIVIDENDS 883 XXXI PAYMENT OF DIVIDENDS . 898 CONTENTS XI CHAPTER PAGE XXXII SURPLUS 908 XXXIII BUDGETARY CONTROL 922 XXXIV EXPANSION 936 XXXV FINANCIAL STANDARDS 947 XXXVI ANALYSIS BASED ON FINANCIAL STANDARDS .... 960 Part VI Financial Abuses and Involvements XXXVII EXPLOITATION BY OFFICERS 967 XXXVIII EXPLOITATION BY DIRECTORS AND STOCKHOLDERS . . 979 XXXIX INSOLVENCY AND RECEIVERSHIP 992 XL REORGANIZATION 1010 XLI ENDS ATTAINED BY REORGANIZATION . . 1018 BOOK III-CORPORATE ACCOUNTING Part I Surplus and Reserve Accounts I THE CORPORATE RECORDS AND ACCOUNTS .... 1033 II THE SURPLUS ACCOUNT 1038 III RESERVE ACCOUNTS 1047 IV CLASSIFICATION OF SURPLUS 1056 Part II The Original Capital of the Corporation V PAR- VALUE STOCK OF ORIGINAL ISSUE FULL-PAID AT ONCE i 1065 VI PAR- VALUE STOCK OF ORIGINAL ISSUE NOT FULL-PAID AT ONCE 1076 VII STOCK SUBSCRIPTION SYSTEM 1086 VIII SALE OF STOCK BELOW OR ABOVE PAR 1096 IX TREASURY STOCK WITH A PAR VALUE noi X PAR- VALUE DONATED STOCK 1106 XI CAPITAL STOCK WITHOUT PAR VALUE 1113 XII NON-STOCK CORPORATIONS 1128 Part III Special Cases in Capital Stock Transactions XIII MISCELLANEOUS STOCK TRANSACTIONS 1133 XIV DIVIDENDS 1142 XV TYPICAL CORPORATE ORGANIZATIONS 1156 Xll CONTENTS CHAPTER XVI INCORPORATION OF SOLE PROPRIETORSHIP XVII INCORPORATION OF PARTNERSHIP PAGE . 1165 . 1172 XVIII XIX XX XXI XXII XXIII XXIV Part IV Bonds and Funds BOND RECORDS AND ACCOUNTS 1185 BOND SALES . . . .,<* > * * '^i *T V J* II ^ BOND INTEREST . . . 1202 BOND DISCOUNT AND PREMIUM 1213 PRINCIPLES OF FUND ACCOUNTING 1225 ENTRY OF FUND TRANSACTIONS 1236 REDEMPTION OF BONDS 1247 Part V Corporate Combinations XXV COMBINATION BY LEASE 1259 XXVI HOLDING COMPANIES 1268 XXVII COMBINATION BY MERGER OR PURCHASE 1278 Part VI Dissolution, Reorganization, Receivership XXVIII VOLUNTARY DISSOLUTION OF CORPORATIONS . XXIX REORGANIZATION BY AGREEMENT XXX RECEIVERSHIP AND REORGANIZATION XXXI RECEIVERSHIP AND SALE Part VII Corporation Statements XXXII XXXIII XXXIV XXXV XXXVI CLOSING THE BOOKS FORMS OF STATEMENTS CONSOLIDATED STATEMENTS CONSOLIDATED STATEMENTS (Continued) PREPARATION OF FEDERAL INCOME TAX RETURNS 1297 1307 1312 1331 1349 i3S4 1373 1384 1399 BOOK IV CORPORATE FORMS Part I Forms Relating to Organization I CHARTER FORMS . . . Form 1. New York Charter 2. New Jersey Charter 1425 CONTENTS xiii CHAPTER PAGE 3. Delaware Charter 4. Delaware Charter No-Par-Value Shares II SPECIAL CHARTER CLAUSES 1442 Form 5. Advertising 6. Amusement Devices 7. Automobiles 8. Automobiles and Garage 9. Bonds and Securities 10. Brick Machinery 11. Building Materials 12. Cloaks and Garments 13. Contracting and Building 14. Cotton and Textile Fabrics 15. Dairy and Farm Products 16. Department Store 17. Drugs 18. Dry-Goods 19. Electrical Supply Company 20. Engineering Mechanical 21. Express and Delivery 22. Films and Motion Pictures 23. Furniture 24. Gas and Electric Fixtures 25. Hardware 26. Heating Apparatus 27. Hotel 28. Ice Company 29. Inventions and Patents 30. Inventions and Patents 31. Jewelry 32. Leather 33. Lighting and Heating 34. Locks 35. Lumber 36. Manufacturing (General) 37. Meat and Cattle 38. Metal-Working 39. Mining 40. Oil 41. Opticians 42. Paints and Painters' Supplies 43. Periodical or Newspaper 44. Photographic Apparatus 45. Pianos and Musical Instruments 46. Printing 47. Railroad Construction 48. Real Estate 49. Refrigerating Company 50. Schools , 51. Securities Company (New York) 52. Smelting and Allied Operations (New Jersey) 53. Textile Fibers xiv CONTENTS CHAPTER PAGE INCLUSIVE CLAUSES 54. To Buy and Hold Real Estate 55. To Conduct Any Other Business 56. To Acquire Other Enterprises 57. To Carry on Business in Other States 58. To Promote Other Undertakings 59. To Enter Into Contracts 60. To Borrow Money 61. To Acquire the Company's Own Stock 62. To Acquire Stock of Other Companies 63. Strengthening Clause 64. Interpretation Clause III BY-LAWS FORMS 1463 Form 65. By-Laws Short 66. By-Laws Extended IV SUBSCRIPTION LISTS 1474 67. Subscription List Simple Form 68. Subscription Blank Individual 69. Subscription to Bank Stock Individual 70. Subscription List Trustee's 71. Subscription List Agreement with Promoters V SUBSCRIPTION RECEIPTS AND RECORDS 1479 Form 72. Trustee's Receipt 73. Treasurer's Receipt for Instalment 74. Treasurer's Receipt for Stock Subscription 75. Stock Scrip 76. Indorsement Form for Stock Scrip 77. Assignment of Subscription and Payments VI STOCK CERTIFICATES 1484 Form 78. Stock Certificate Common Stock 79. Stock Certificate No-Par-Value Shares 80. Stock Certificate Preferred Stock 8 1. Assignment of Stock Certificate 82. Voting Trustees' Certificate 83. Voting Trustees' Certificate Simple Form 84. Assignment of Voting Trustees' Certificate VII STOCK BOOKS 1493 Form 85. Stock Transfer Book 86. Stock Book or Stock Ledger 87. Broker's Stock Book (New York) 88. Corporate Stock Book (New York) VIII ORGANIZATION MEETINGS OF STOCKHOLDERS .... 1498 Form 89. Minutes of Stockholders' First Meeting CONTENTS . xv CHAPTER PAGE go. Call and Waiver of Notice Stockholders' 91. Proxy First Meeting of Stockholders 92. Inspector's Report 93. Waiver of Notice of Assessment IX ORGANIZATION MEETING OF DIRECTORS . . . . . 1504 Form 94. Minutes of Directors' First Meeting 95. Call and Waiver Directors' 96. Secretary's Oath of Office 97. Proposal to Exchange Property for Stock 98. Assignment of Subscriptions 99. Call for First Directors' Meeting X OPTIONS AND VOTING TRUST AGREEMENTS . . . .1512 Form too. Option on Capital Stock 101. Option on Business and Property 102. Option on Real Estate 103. Assignment of Option 104. Voting Trust Agreement Part II Forms Relating to Corporate Meetings XI CALLS AND WAIVERS FOR SPECIAL MEETINGS . . .1519 SPECIAL MEETINGS OF STOCKHOLDERS Form 105. Call and Waiver for Special Meeting of Stockholders 106. President's Call for Special Meeting of Stockholders 107. President's Call for Special Meeting of Stockholders Formal 108. Directors' Call for Special Meeting of Stockholders 109. Directors' Instructions for Special Meeting of Stock- holders no. Directors' Resolution for Special Meeting of Stock- holders in. Stockholders' Request for Special Meeting 112. President's Indorsement of Stockholders' Request 113. Stockholders' Call for Special Meeting SPECIAL MEETINGS OF DIRECTORS 114. Call and Waiver for Special Meeting of Directors 115. Agreement for Consent Meeting of Directors 116. President's Call for Special Meeting of Directors 117. Directors' Call for Special Meeting of Directors XII NOTICES OF MEETINGS . . .1529 STOCKHOLDERS' MEETINGS 118. Notice of Special Meeting of Stockholders 119. Publication Notice of Special Meeting of Stockholders 120. Publication Notice of Special Meeting of Stockholders 121. Notice of Annual Meeting xvi . CONTENTS CHAPTER PAGE 122. Publication Notice of Annual Meeting 123. Publication Notice of Annual Meeting' 124. Publication Notice of Annual Meeting DIRECTORS' MEETINGS 125. Notice of Special Meeting of Directors 126. Notice of Regular Meeting of Directors XIII PROXIES FOR MEETINGS 1535 Form 127. Proxy Simple Form 128. Proxy Unlimited 129. Proxy Time Limited 130. Proxy for Particular Meeting 131. Proxy Limited as to Stock 132. Proxy for Annual Meeting Formal r 33- Corporate Proxy 134. Revocation of Proxy XIV MOTIONS AND RESOLUTIONS 1543 Form 135. Motion Instructing Secretary to Cast Vote 136. Motion Instructing Secretary to Cast Vote Formal 137. Motion to Amend By-laws 138. Motion to Pay Bills 139. Motion to Employ General Manager 140. Motion to Appoint an Investigating Committee 141. Stockholders Resolution for Sale of Entire Assets 142. Stockholders' Resolution Authorizing Consolidation 143. Stockholders' Resolution to Amend By-laws 144. Directors' Resolution to Open Bank Account 145. Directors' Resolution Designating Depositary 146. Directors' Resolution Designating Bank 147. Directors' Resolution Authorizing Issue of Stock 148. Directors' Resolution Authorizing Contract 149. Directors' Resolution Declaring Dividend 150. Directors' Resolution Declaring Dividend Preferred Stock 151. Directors' Resolution Declaring Dividend Preferred and Common Stock 152. Directors' Resolution Appointing Managing Director 153. Directors' Resolution Calling Special Meeting of Stock- holders 154. Directors' Resolution to Sell Bonds 155. Directors' Resolution to Purchase Property 156. Directors' Resolution for Settlement of Claim 157. Directors' Resolution Ratifying Sale of Property 1*58. Directors' Resolution Removing Officer (New York) 159. Directors' Resolution for Sale of Entire Assets XV FORMS USED IN CONNECTION WITH MEETINGS . . . 1553 Form 160. Secretary's List of Stockholders 161. Outline Minutes for Annual Meeting CONTENTS xvii CHAPTER PAGE 162. Oath of Inspectors of Election New York 163. Certificate of Inspectors of Election New York 164. Acknowledgment of Inspectors' Certificate 165. Certificate of Inspectors of Election General 166. Ballot at Annual Meeting 167. Ballot at Annual Meeting Formal XVI MINUTES OF CORPORATE MEETINGS 155-.; Form 168. Minutes of Annual Meeting of Stockholders 169. Minutes of Special Meeting of Stockholders 170. Minutes of Adjourned Meeting of Stockholders 171. Minutes of Regular Meeting of Directors 172. Minutes of Adjourned Meeting of Directors 173. Minutes of Special Meeting of Directors Part HI Forms Relating to General Procedure XVII MISCELLANEOUS NOTICES 1569 SUBSCRIPTION AND ASSESSMENT NOTICES Form 174. Instalment Notice 175. Notice of Stock Assessment 176. Notice of Stock Assessment Statutory 177. Notice of Sale of Delinquent Stock NOTICES RELATING TO DIVIDENDS 178. Dividend Notice Mailing 179. Dividend Notice Publication 180. Notice Accompanying Dividend Check 181. Dividend Notice 182. Dividend Notice Common Stock 183. Dividend Notice Common and Preferred Stock 184. Dividend Notice Mailing Orders Requested 185. Mailing Order for Dividends NOTICES OF APPOINTMENT 186. Notice of Election as Director 187. Notice of Election as Director Acceptance Requested 188. Notice of Appointment as General Manager 189. Tender of Position as Sales Manager XVIII RESIGNATIONS 1578 Form 190 Resignation of Director 191. Resignation of Director Effective on Acceptance 192. Resignation of Director Peremptory 193. Resignation of Director Future Date 194. Resignation of President Conditional 195. Resignation of Treasurer xviii CONTENTS CHAPTER PAGE XIX CORPORATE AND OFFICIAL SIGNATURES 1582 Form T?)6. Official Signature Informal 197. Official Signature Formal 198. Corporate Signature Informal 199. Corporate Signature Formal 200. Testimonium Clauses Corporate Signature Seal Attested 201. Testimonium Clause Two Corporate Signatures 202. Testimonium Clause Corporate and Individual Sig- natures 203. Testimonium Clause Corporate and Individual Sig- natures 204. Testimonium Clause Signature by Agent XX CHECKS, RECEIPTS AND NOTES 1588 CORPORATE CHECKS Form 205. Check Corporate Signature 206. Check Countersigned 207. Check Official Signatures 208. Check Official Signatures Purpose Stated 209. Check Draft Form 210. Dividend Check 211. Indorsement of Corporate Check 212. Indorsement of Check for Deposit 213. Corporate Draft CORPORATE RECEIPTS 214. Corporate Receipt 215. Corporate Receipt Official Signature 216. Dividend Receipt CORPORATE NOTES 217. Corporate Note By President 218. Corporate Note By Treasurer 219. Collateral Note On Demand 220. Corporate Note Collateral Security XXI CERTIFICATIONS 1598 Form 221. Certificate to Service of Notice 222. Affidavit to Service of Notice 223. Affidavit to Publication of Notice 224. Certified Resolution Designating Bank 225. Certification of Resolution Designating Bank 226. Certification of Resolution 227. Certificate of Election of Treasurer 228. Certificate of Election of Officers 229. Certification of Transcript from By-laws 230. Certification of By-laws as a Whole 231. Certification of Transcript from Minutes 232. Certification of Minutes President and Secretary 233. Secretary's Affidavit to Minutes 234. Notarial Exemplification of Minutes CONTENTS xix CHAPTER PAGE 235. Treasurer's Affidavit to Corporate Statement 236. Notarial Acknowledgment New York XXII POWERS OF ATTORNEY, CONTRACTS AND ASSIGNMENTS . . 1606 POWERS OF ATTORNEY Form 237. Power of Attorney To Receive Dividends 238. Power of Attorney To Collect Money 239. Power of Attorney To Deliver Deed 240. Power of Attorney To Manage, Sell, and Deed Land 241. Revocation of Power of Attorney CORPORATE CONTRACTS AND ASSIGNMENTS 242. Corporate Contract 243. Corporate Bill of Sale 244. Assignment of Contract 245. Assent to Assignment of Contract 246. Assignment of Contract By Indorsement 247. Assignment of Patent Individual to Corporation XXIII BONDS OF INDEMNITY 1616 Form 248. Treasurer's Bond Personal 249. Indemnity Bond for Lost Stock Certificate Part IV Forms Relating to Bond Issues XXIV BOND ISSUES THE BOND 1619 Form 250. Coupon Bond 25oa.Coupon 251. Trustee's Certificate 252. Debenture Bond XXV BOND ISSUES THE DEED OF TRUST 1623 Form 253. Deed of Trust Part V Corporate Records, Reports, and Calendar XXVI MISCELLANEOUS BOOKS AND RECORDS 1633 Form 254. Subscription Journal 255. Instalment Book 256. Transfer Register 257. Dividend Book Personal Payment 258. Dividend Book Payment by Mail 259. Bond Register 260. Index of Bondholders 261. Coupon Register CONTENTS CHAPTER XXVII REPORTS PAGE 1643 -Statement of Form 262. President's Annual Report 263. Report on Employees and Pay-Rolls 264. Treasurer's or Comptroller's Report S Earnings 265. Treasurer's or Comptroller's Report Balance Sheet 266. Report of Committee on By-Laws XXVIII CORPORATE CALENDAR l6 53 Form 267. Corporate Calendar (New York) CORPORATION PROCEDURE BOOK I CORPORATE LAW Part I The Corporate Form CHAPTER I INTRODUCTION i. Business Organization and the Law All business relations and organizations depend for their binding quality on the law. For that reason this introductory chapter presents in outline form a few of the more basic prin- ciples of the law of contracts, of agency, and of partnership, and an equally brief discussion of legal phraseology and of the distinction between common and statutory law just those matters directly involved in the consideration of business organization. 2. Law of Contracts All business relationships are founded on contracts. A con- tract is an agreement of such a nature that it may be enforced at law. The sale of goods, the appointment of agents, the employment of assistants, and all other business transactions are contracts, or are based on contracts. Both partnerships and corporations are based on contracts. The accepted legal definition of a contract is "an agreement between two or more parties, for a sufficient consideration, to do or not to do some specified thing or things." It is an agreement and the minds of the parties "must meet." There must be two legally competent parties to a contract and there may be more. 3 4 CORPORATE LAW . [Bk. I- There must be a "consideration," that is, a legal induce- ment or recompense in order to bind each party. If there were no consideration, it might be a matter of honor for a man to keep his promise, but the law would not compel him to keep it or to give the other party damages if he failed to keep it. There must be an obligation, or thing to be done. It may be to sell something, or to do something, or to pay money, or it may be not to do something the person would otherwise be free to do or not to do. 3. Law of Principal and Agent In modern business life many things are necessarily done by proxy. Consequently, the larger proportion of men in busi- ness are not acting for themselves but as agents for others. In all forms of partnership and corporate activity the business that is done is done by agents. Therefore the subject comes up again and again in this volume. An agent is one who represents or is authorized to represent another person in some business transaction or transactions. The person or the corporation who is represented by an agent is called the "principal." The relation between the principal and the agent is termed "agency." The agent may be known as "agent," "factor," "broker," "attorney," "proxy," "delegate," or "representative." A part- nership is represented by its members who are agents for the firm. A corporation is represented by its officers who are its agents. A corporation can contract in no other way than through its agents. 4. The Law of Partnership There are but two forms of business organization in general use: the partnership and the corporation. In this place it is only desired to stress those features of the law of partnership that differentiate it from the corporation. These features are inherent in the two forms of organization. Ch. i] INTRODUCTION 5 A partnership is the result of a contract between two or more competent parties, to combine their money, property, skill, or labor for the transaction of some lawful business for profit it is nothing more than a group of individuals considered as individuals. In a corporation, on the other hand, the individuals are merged in the corporate entity. That is, the law allows a corporation to act as one person, while a partnership must act as a group. Hence, in a partnership each member is liable for the firm debts as if they were his own, while in a corporation a member is liable only for what he agrees to invest or has invested in its stock. 5. The Common Law The common law had its origin at a very early date. As soon as men commenced to live in communities, certain rules of conduct were evolved, certain uniform methods of doing things grew up, and certain customs of dealing with each other generally prevailed. When disputes arose, they were decided by these rules and methods and customs. These, being made the basis of decisions, gradually acquired the force of established law, and so after a time, without any legislative action, the early communities came to have a considerable body of law which was called in England the "common law." When this country broke away from England at the time of the Revolution, this common law was in use in the Thirteen Colonies, was retained thereafter, and became the foundation for our state and national systems of law. When the common law is referred to, it means this inherited law in contradistinc- tion to the laws passed by state legislatures and Congress, which are referred to as "statutory law." Many features of the common law have been made doubly binding by being adopted by legislatures and enacted as part of the statutory law. On this account the common law and the statutory law largely overlap. 6 CORPORATE LAW jBk I- 6. The Statutory Law The legislatures of the states and the Congress of the United States pass laws or statutes. These collectively are desig- nated as statutory law. The modern corporation is a creation of the law as passed by a legislature or by Congress. Hence, in dealing with cor- porate organization or the technical management of corpora- tions it is always necessary to keep in close touch with the statutes. As these statutes differ in the different states and are changed frequently, it is not possible to bring them all into a work such as this. It is, as intimated, necessary for the corporation lawyer or official responsible for the technical conduct of his corporation to keep in close touch with the state laws and their changes. In the more populous states this is easily done as careful com- pilations may be secured, giving the laws relating to corpora- tions and the decisions of the courts on corporate matters. In other states the authorities usually issue the corporate laws in pamphlet form, and they may be had by application to the proper state authority usually the secretary of state. The present book gives the principles of corporate law that prevail in all the states and form the basis of the statutory law, and in many cases calls attention to the variations of the basic law found in different states. For a working knowledge of these state laws, however, with their numerous variations, refer- ence must be made to the statutes of the particular state for which the information is desired. CHAPTER II BUSINESS ORGANIZATION 7. Economic Necessity for Organization 1 In a primitive society, no organization other than the natu- ral operations of the family unit would be called for; but so soon as any progress to a higher social order was to be made, some form of organized or co-operative effort was unavoidable. The greater effectiveness of team-work of the united effort of two or more working together for a common purpose gave those who could so co-operate a great advantage over the soli- tary individual. The same thing was true as each step in advance was taken, and for this reason the earlier forms of organization employed in business have in the course of ages developed into the present-day partnership and corporation. 8. Individual Management It is probable that there was a time when no business co-operation between equals was possible, and all trade and industry were carried on by individuals of exceptional initia- tive with the help of paid employees and slaves. Some such survivals are yet found, men of great ability and will-power men who cannot brook opposition and who have so accus- tomed themselves to playing the game alone that they cannot or will not co-operate with others in any form of organization. Such men may go high in the business world but they neces- sarily work at a disadvantage compared with those who are able to co-operate with their fellows. It is possible to carry on successfully farming and various small businesses in this manner at the present day, and such 1 See also Book II, Ch. II, "Organization for Business." 7 CORPORATE LAW [Bk. I- individual enterprises often give the future business leader a valuable training in initiative and responsibility. When, how- ever, we come to enterprises of greater size, it is practically always necessary to take a partner or partners, or to incor- porate. There have been some few exceptions. For instance, John Wanamaker for many years conducted his great business under his individual management. He was, however, finally driven to incorporation, and at the present time there is in this country no single instance of a really great business con- ducted as a sole proprietorship. 9. Partnership The first advance in business organization was when two men found that they could work together in transactions for their joint advantage. It involved such relations of trust and confidence that in the early days it rarely extended to more than two partners. Partnership has always involved mutual authority and mutual responsibility. Each partner is an agent for the firm with unlimited powers. He can, in the scope of the partner- ship business, contract for the firm; and the firm is bound, and each partner to the extent of his entire fortune is also bound. Many men have been ruined by the fraud or the blundering of their business partners. This is the defect of copartnership as a form of business organization. Each addi- tional partner increases the risk. It is not safe for anyone to put capital into another's private business save under special con- ditions or with specific contract reservations because thereby he becomes himself a partner and may lose not only his invest- ment but also all that he has outside. It is this peculiar fea- ture of partnership liability that limits the utility of the part- nership as a form of business organization and has made the corporation so generally preferred. 2 2 See Ch. Ill, "Advantages of the Corporate Form"; also Book II, Part I, "The Cor- poration." Ch. 2] BUSINESS ORGANIZATION 9 On the other hand, partnership has certain qualities of effectiveness which under some conditions make it superior to every other form of business organization. During the inves- tigation of the Steel Trust, Andrew Carnegie, who for years operated the business later acquired by the Carnegie Steel Company, made the following statement: I don't believe that any corporation can manage a business like a partnership. When we were partners I felt that we could run around corporations. You take thirty-five young men interested in watching even a leak in a spigot, and no corporation can compete with such an organization in any business. There are practically no large commercial undertakings in the country conducted as partnerships. Endicott Johnson Corporation, Arbuckle Brothers, and the Baldwin Locomotive Works were among the last to "succumb," but all these are now corporations. Joint-stock companies are a form of partnership in which the investments of the partnership are represented by shares of stock. The holders of stock are, however, partners and are subject to the full liability of partners; on this account it is a form of business association rarely used, 10. Business Corporations The favored modern type of business organization is the stock corporation. It owes its pre-eminence to the fact that it allows those who are not actively engaged to invest money in a business safely, that is, without risk of greater loss than the amount actually invested, and at the same time participate in full proportion in any profits that may be made. The impor- tance of this feature of the corporate organization is found in the fact that modern industry requires large amounts of capital. In our day practically all production is capitalistic. There are to be sure, marked differences in the degree to which capitalism is carried in various industries. Some industries, from their very 10 CORPORATE LAW [Bk. I- nature, seem able to use more capital than others located in the same city or country; and the industries in one city or country may, in general, use more than those in another. But, however great these variations, the fact remains that most industries can use all the capital available, and the more they use the higher is the productive efficiency to which they attain. 3 No form of business organization affords the facilities for securing capital from outside investors that are found in the stock corporation. On this account it is the typical modern business association, and with slight variations of form is found in use in every civilized country in the world. ii. The Charter 4 A partnership is formed by contract between the partners interested. A corporation is formed by a contract between the state acting through the state authorities on one hand and the incorporators (i.e., those who organize the corporation) on the other. The evidence of this contract is the charter, which is also termed a "certificate of incorporation," or in some states the "articles of association." The charter is an instrument in writing authorizing the incorporators and those that they asso- ciate with themselves later, to transact the business for which they have organized as a corporation. The right of organization to be a corporation and to carry on its particular business is based solely on its charter, which is its authority for existence. 12. The By-Laws 5 Because a corporation requires more detailed rules of action, its charter or the laws of the state give it the right to enact by-laws for its government. The charter is the basic law of the corporation, but these by-laws are adopted by its sub- scribers or stockholders to meet its need for more detailed 1 Taylor on Principles of Economics, p. 90. See Part V, "The Charter." * See Part VI, "The By-Laws." Ch. 2] BUSINESS ORGANIZATION II regulation. By-laws prescribe the issues and the transfers of stock, the meetings of stockholders and directors, and the power and authority of the directors. They also prescribe what officers the corporation shall have and their duties. In addition, they direct how the moneys and property of the company shall be kept and handled and how the by-laws themselves from time to time may be amended and changed. 13. Stock 6 For their varying investments in a stock corporation, the investors receive stock, which in this country is divided into equal portions or shares, usually of the face or nominal value of $100 each, though this may be $50 or $10 or less. Within the last decade, shares of no par value have been authorized. The amount of the shares issued makes up the capital of the cor- poration. The total amount of stock that may be issued is limited by the charter of the corporation. 14. Stockholders 7 Those who subscribe for stock in a company or who later buy stock from those who have subscribed, are termed "stock- holders." They are entitled to vote and to share in profits, in proportion to the number of shares each holds. If they have subscribed for stock, they are liable for whatever the par value of the stock may be, and when they have paid this they are entitled to certificates as evidence of payment and as a matter of convenience in making transfers of their shares. 15. Directors 8 The stockholders of a corporation are usually too numerous and too much occupied to manage its affairs. Therefore, under the plan of corporate organization the stockholders elect three or more directors who collectively and acting as a board, have 1 See Part III, "The Stock System." ' See Ch. XVII. "Stockholders." See Ch. XVIII. "Directors." 12 CORPORATE LAW [Bk. I- the entire management and control of the corporate property and business. The directors must act as a board, in a duly assembled meeting, with a quorum present. 16. Officers 9 The board appoints officers and agents through whom it acts. The usual officers are a president, a vice-president, a treasurer, and a secretary. The duties of the president are to preside at meetings, to exercise general supervision over the affairs of the corporation, and to sign such instruments and perform such other proper duties as the board may direct. The usual duties of the treasurer are to care for the funds and finances of the corporation, and to sign such instruments as he is authorized to sign. The secretary's duties are to keep the records of the meet- ings, to notify the members of meetings, and to perform such other secretarial duties as the board may prescribe. In some companies other officers are appointed, such as comptrollers, auditors, managers, counsel, and assistants to officers. Their duties may be prescribed in the by-laws, or by usage, or by resolution of the board. See Ch. XIX, "Officers." CHAPTER III ADVANTAGES OF THE CORPORATE FORM 17. The Purpose of Business Organization The object of all business organizations is to combine good management with sufficient capital to conduct some business undertaking profitably. Because the corporation accomplishes this end more simply and more efficiently than any other form of organization in use, it has become the usual form in which all of the larger business enterprises are conducted. It is possible that the future will see the evolution of some improved form of business organization. Partnerships may perhaps be allowed to secure needed capital by issuing profit- sharing certificates that will involve the holder in no additional liability. Undoubtedly the corporate form could be much improved. It is, however, the best form of business organization now available. 1 8. Characteristic Features of Corporate Form As already stated, there are but two forms of business combination commonly used for conducting a business or an enterprise the partnership and the corporation. The one is easily entered into, and as easily dissolved; the other is formal and more permanent. Men may drift into partnership; the law frequently implies it for them, or it may be made by a simple verbal agreement. Incorporation, on the contrary, may be had only by deliberate purpose, carried into effect through prescribed forms of law. A partnership may, and frequently does, exist without the knowledge of the partners; an incorporation is impossible except with the formally ex- pressed concurrence and participation of all the parties. 14 CORPORATE LAW [Bk. I- The general and steadily increasing preference for the corporation over the partnership as a form of business organiza- tion is due to the very material advantages offered by the corporation, which may be summarized as follows : 1. Its limitation of stockholders' liabilities to a definite amount. 2. Its distinct legal entity for all business purposes. 3. The stability and permanence of its organization. 4. The representation of the different interests in the corporation and its property by transferable shares. 5. The management of the business by an elected board of directors, acting through officers and agents. 6. The greater ease of securing capital under the corporate form because of its safeguards and advantages. These characteristic features of the corporate form are severally considered in the following sections of the present chapter. 19. (i) Limited Liability The subscriber to stock and the holder of stock not fully paid for are liable to the corporation, and indirectly to its creditors, up to the par value of their stock. In other words, if a corporation becomes insolvent, a subscriber to its stock whose subscription is not fully paid, or a holder of stock not fully paid for, can be held liable for the corporate debts up to the amount necessary to make his stock fully paid. In most states a subscription to stock or the holding of stock involves no further liability than this, and as soon as the face value of stock is paid this liability ceases and the holder is no longer, as a stock- holder, responsible for the corporation and its doings. 1 Stockholders in national banks, and generally stockholders in banks, trust companies, and other moneyed corporations, are, 1 See }J 72, 174-176; see also i Cook on Corp., 212, 213, 214, 241, 242; United States v Stanford, 161 U. S. 412 (1896). Ch. 3] ADVANTAGES OF CORPORATE FORM 15 in addition to any subscription liability, held liable for an amount equal to the par value of their stock in case of the insolvency, of their corporation. In some few states stockholders may be held for any debt due by a corporation -to a laborer, servant, or other employee. The liability on unpaid stock is generally understood and is not inequitable. The further statutory liabilities, save those of moneyed corporations, are unfortunate, because of lack of uniformity and their uncertain action. Not infrequently they work serious hardships where stock is purchased in ignorance of their existence. They are always productive of litigation and the states in which they are found are to be avoided for purposes of incorporation. 2 These statutory liabilities, however, are exceptional and in the great majority of the states the one general rule pre- vails that a stockholder whose stock has once been paid in full is liable neither to assessment by the corporation nor to action by its creditors. The property of the corporation in which he is interested may be swept away, but his liability is fixed and limited. His investment will be lost but that is the worst that can happen. The unlimited responsibility of the partnership does not exist. 20. (2) Legal Entity of Corporation In the partnership every member must be made a party to all actions at law either by or against the firm, and no partner may sue or be sued by the partnership as a partnership. He cannot contract with his firm, nor enforce its obligations to him. The great inconvenience of this is manifest. On occasion it results in serious loss and injustice. It is a material defect of the system. The corporation, on the contrary, is a distinct legal entity, entirely apart from its membership. It may sue and be sued See 172. 16 CORPORATE LAW [Bk. I- under the corporate name. It may contract freely with its stockholders and even, under proper conditions, with its officers and directors. It may bring suit to enforce these contracts, and in turn may be sued by stockholders, officers, or directors. In short, for all purposes of ordinary business the corporation has a distinct, individual existence of its own. 3 In the famous Dartmouth College case, 1 Chief Justice Mar- shall described a corporation as "an artificial being, invisible, intangible, and existing only in contemplation of law." It has been held that this definition should be limited, especially in those cases where it is sought to use the legal fiction of cor- porate entity to evade legal obligations or to work fraud or injustice. A later writer says: While a corporation may from one point of view, be considered as an entity without regard to the corporators who compose it the fact remains self-evident that a corporation is not in reality a person or a thing distinct from its constituent parts. The word "corporation" is but a collective name for the corporators or members who compose an incorporated association; and where it is said that a corporation is itself a person, or being, or creature, this must be understood in a figurative sense only. 6 21. (3) Permanence The ordinary partnership depends for its continued existence upon the continued life, sanity, solvency, and consent of each one of its members. It is always readily, and often unavoidably, terminated. This easy and at times undesirable dissolution is disturbing, and, with its possible resulting loss of business and good-will, is a serious defect of the system. In the corporation, permanence and stability are charac- teristic features. The organization endures until terminated: i Cook on Corp., || 1.6, n. Trustees of Dartmouth College v. Woodward, 4 Wheaton (U. S.) 518 (1819). * Morawetz on Private Corporations, } { I, 227; Garrigues v. Int. Agricultural Corporation, 159 App. Div. (N. Y.) 877 (1913). Ch. 3] ADVANTAGES OF CORPORATE FORM 17 1. By voluntary dissolution, which must usually though not invariably be by unanimous consent of the stockholders. 2. By the expiration of the period for which it was formed. 3. By judicial proceedings. 4. By forfeiture of charter by the state. The foregoing are the only methods recognized by law by which the corporation may be terminated. The lives, the men- tal or financial condition of its stockholders, the antagonism of an individual or faction, need have no effect on its existence. This permanence adds materially to the value and efficiency of the corporation as a mechanism for the transaction of business. In some few states the maximum term for which charters are granted is twenty years. In others it is fifty. In others there is no limitation, and the duration of the corporation may be fixed at any desired period, or may at least in theory be made perpetual. 6 22. (4) Stock System In a partnership there is no satisfactory or generally recog- nized method of expressing and representing the individual interests of the partners. Nor is there any way, save by con- sent of all the parties interested, by which a partner may transfer his interest in whole or in part to another person. Such a transfer, unless by general agreement, dissolves the firm. In stock corporations the exact reverse obtains. Under a fixed and well-ordered system the various interests of the parties in whom the ownership of the corporation rests are expressed as equal parts, or shares, of the whole. These shares are, as a matter of convenience, represented by quasi-negoti- able certificates of stock, which may be transferred as desired with but little formality and without affecting the operations 2 Cook on Corp., i 628; Swan, etc., Co. v. Frank, 148 U. S. 603 (1893). 1 8 CORPORATE LAW [Bk. I- of the corporate business. Each stockholder votes according to the number of shares he holds, and participates in dividends in like proportion. The convenience and the obvious business advantages of this method of holding and transferring interests in the corporation are the most attractive features of the cor- porate system. 23. (5) Corporate Mechanism The partnership has no definite method of action or sys- tem of management. Any partner may bind the partnership within the scope of its business and no one partner has any more legal authority than another in partnership affairs. There is 'no legal way of enforcing the wishes or decisions of the majority. On the other hand, the stable, well-defined, and orderly system of administration characteristic of the cor- poration is one of its most admirable and important features. The election of a board of directors by the stockholders vot- ing according to their stock interests; the election of officers and the appointment of agents by this board for the direct con- duct of the business; the supervision and control of these offi- cers and agents by the board; the orderly action of the board as a body at meetings palled in accordance with by-law or charter requirements these constitute the best working mechanism for the conduct of a business enterprise that has yet been devised. The several functions of the stockholders, directors, and officers, the well-defined laws and usages governing every fea- ture of corporate operation, the records to be kept, the reports to be made, and the protection afforded its members, combine to make a system compared with which the workings of the ordinary partnership are crude and inadequate. The corporate organization may be and should be based on a division of powers and duties and the operation of mutual checks and balances. If well arranged and properly conducted its operation is effective and satisfactory. It must be observed, Ch.3l ADVANTAGES OF CORPORATE FORM 19 however, that the ideal corporate organization is not ordinarily attained, being lost through ignorance, negligence, or lack of experience. Safeguards and checks are omitted or purposely set aside by promoters and exploiters; a charter and by-laws well adapted for one corporation often are stupidly duplicated for the use of another corporation of wholly different design and purpose; frequently measures of protection or convenience are omitted through ignorance on the part of the incorporators. To avoid such errors and, with due regard to the rights of all concerned, to secure an effective and smoothly working corporate mechanism, requires skill and intelligence in the organization of the corporation. To maintain its proper oper- ation thereafter demands an honest, capable administration and watchful care on the part of those interested. It may be stated in passing that no system of conducting business has been or can be devised that will protect the in- terests of those concerned automatically and without effort on their part. Our corporation laws are, it must be admitted, far from perfect, but the best laws are of no effect unless enforced, and the most effectual and well-devised system of business organization may be turned to evil ends unless efforts in this direction are opposed. All that can or should be done by the corporate organization is to afford the weak an opportunity to protect themselves should the need arise. If they will not avail themselves of such opportunity when the time comes, it is they who are at fault, not the system. 24. (6) Attractiveness to Investors Speaking generally, any considerable combination of capi- tal is impossible under the partnership system. No matter what the merits of the enterprise nor how great the induce- ments offered, they are outweighed by the dangerous liabilities and uncertain operation of the unincorporated form. For this reason any appeal to the investing public on the basis of a partnership or joint-stock association is foredoomed to failure. 20 CORPORATE LAW [Bk. I- On the other hand, the corporate form has been found most attractive to investors. It enables them to invest or par- ticipate to a definite extent without rendering themselves in- definitely liable. It has a continued period of duration, usually lasting until insolvency or voluntary liquidation. The busi- ness interest obtained may be sold, transferred, or transmitted to posterity with little formality and without material expense. Its mechanism operates in well-defined grooves and the rights and liabilities of all concerned are well known. It has its own personality, and stockholders are not involved by its actions, nor are they responsible for its obligations beyond their liability, if any, on stock. For these reasons, if it is desired to raise capital for an enterprise or to increase the amount already invested, the ob- vious method and the one almost invariably pursued is to in- corporate the undertaking and sell the securities of the company so formed. Outside investors may be allowed to come in on the same basis as the originators, but because those who have created the enterprise generally wish to control it, and later investors are more desirous of safe profits, it is usual to divide the stock into common or voting stock and preferred stock with no voting power but with a preferred dividend, that is, a dividend equal to or a little more than the usual interest rate, paid before the common stock receives anything. 7 In this connection it may be observed that if the attrac- tiveness of the corporation as a field for investment is to be pre- served, it is essential that those features which serve to protect the interests of the investor shall be maintained and their scope enlarged. Under existing laws it has happened many times that exorbitant and even fraudulent prices have been paid for the properties taken over by newly organized corpo- rations. Undue power and emoluments have been given to 7 See Ch. XI, "Preferred Stock"; see also i 101. Ch. 3 ] ADVANTAGES OF CORPORATE FORM 21 the original promoters. Rights .of minority stockholders have been denied, and the smaller investors have been debarred from any knowledge of the inner corporate operations. The immediate result of such practices has been very prejudicial to promotion. Much money that would otherwise have been available for the development of new enterprises has gone into the better known bonds and particularly into the safe haven of the savings bank, where returns are small but where all the conditions are clearly defined and both principal and profits are secure. T.' 25. Resume From the preceding considerations it seems that the char- acteristic features of the corporate form which have led to its extended use are: 1. Its efficiency, which is curtailed only by ignorance or lack of skill in its organization. 2. Its convenience, which is inherent in the corporate sys- tem and requires no special attention. 3. Its safety, which is the one point above all others that requires attention, not only because it is the one most apt to be overlooked, neglected, or omitted by intent, but because it is the most important feature of any business enterprise in which a number of people are concerned. The corporation is, from its nature, a democratic institution and the safety of the investors' interests should be a first essen- tial. T^he majority must rule, but the rights of the minority demand that this rule be fair, open, and honest. Due adjust- ment of all equities should be made so that all interests are represented, none are favored at the expense of others, the general business is facilitated, and the profits are fairly ap- portioned. This is the true ideal of corporate organization, and that corporation is the most ably organized and conducted which most nearly approaches this ideal. 26. General It seems only fair to give both sides of the shield, and to point out to those proposing to incorporate, certain matters that may well give them pause. Many times small businesses are incorporated when the expense and inconvenience involved are not compensated by the advantages that have been set forth. The corporate form has its advantages and also its dis- advantages. Its advantages have been discussed with some detail in the preceding chapter. Its disadvantages discussed in the present chapter lie mainly in the somewhat invidious taxes imposed upon corporations and the somewhat onerous reports required of them by state and federal legislation. The objection so frequently urged against the corporate form that it does not afford protection to minority interests is considered at length elsewhere. 1 It is practically impossible for a corporation doing business over a wide territory to have that assurance of its rights which a sound and stable business demands. It must keep constantly on the alert to guard itself against the enactment of new legislation and must keep counsel constantly at work to ascertain what the meaning of new laws is. It often happens, that as soon as a particular question has been decided by the courts, the law construed has been repealed and a new one put in its place, of which construction must be had at the cost of litigation and .uncertainty before its effect will be known. The resistance of corporations to statutory regulations gives rise to a popular belief that corporations are not law-abiding bodies, although the corporation may be resting its resistance upon just grounds. Ch. LVIII, "Protection of Minority." Gh.4l DISADVANTAGES OF CORPORATE FORM 23 The corporation must, in opposing what appears to be destructive legislation, pay the price of an unpopularity which reacts in further legislation or in unfavorable verdicts by juries. In the true sense of the words, therefore, it cannot be said that corpora- tions stand before the law with the same rights as individuals. 2 27. Onerous Legislative Requirements Within the last few years the costs and burdens imposed on corporations by the legislatures of the various states and finally by federal legislation have materially increased so much so that before deciding in any specific case to incorporate a business it is advisable to investigate carefully and deter- mine just what obligations the proposed incorporation will entail. Where it is desired to secure the investments of a number of people in a business enterprise, incorporation offers such advantages that it is practically the only possible form, and in such cases the only recourse is to minimize the disadvantages as far as may be done. Not infrequently, however, when the incorporation of an existing partnership or individual business is under consideration, the conscientious lawyer is compelled to counsel against such a step and advise his clients to bear the ills they have rather than to incur the taxes, annual reports, and other onerous burdens imposed on corporations. According to a famous French minister, the whole prob- lem of taxation is, as in plucking geese, to secure the most feathers with the least squawking. Proceeding upon this primi- tive principle, both state and national legislators have found the line of least resistance in the corporation and have taxed it unreasonably. As a matter of fact and fairness, private corporations should not pay higher taxes or be called upon for more onerous reports than individuals or partnerships engaged in like enterprises, save as to the small fees for filing and recording where cor- 2 Sears on Trust Estates as Business Companies (1921), 5 4. 24 CORPORATE LAW IBk. I- porate instruments are required to be filed in public offices. The business corporation, as such, enjoys no franchise or monopoly; it merely employs a convenient form of business organization. If this form facilitates the transaction of busi- ness and is superior to the partnership form of business organi- zation, its use should be encouraged, not hindered. So far as holding corporations and trust combinations are harmful they should be prohibited, for taxes levied on them are no compensation for the harm they do, and do not benefit those who suffer from their abuse of power; public utility corporations may well pay some compensation to the public for the monopolies they enjoy, either in increased taxes or in the form of regulated rates; but ordinary private corporations should not be hampered unnecessarily in any way, and should be taxed only for the property they hold and at no higher rate than individuals and partnerships. In those localities where it is customary to discourage enterprise and punish industry by levying occupation taxes, corporations should pay the same as individuals and partner- ships, but no more. In other words, the corporate form should bear its part of the burden of taxation but should not be handi- capped with more. 28. Summary of Taxes and Reports The taxes and reports required of corporations may be generally summarized as follows: Taxes: 1. Organization taxes payable to the state of incor- poration. 2. Annual franchise taxes paid to the state of incor- poration. 3. Annual taxes on property. 4. State income taxes (in some states). 5. State inheritance taxes (in most states). Ch. 4 ] DISADVANTAGES OF CORPORATE FORM 2^ 6. Stock transfer taxes (in New York, Massachusetts, and Pennsylvania). 7. Taxes and license fees in each state outside the home state in which the corporation does business. 8. Federal taxes. Reports : 1. Local tax reports. 2. State tax reports. 3. Federal tax reports. 4. Annual reports of officers, etc. 5. Reports in each state outside the home state in which the corporation does business. These corporate taxes and reports will be severally con- sidered in the following sections. TAXES 29. (i) Organization Taxes These are taxes imposed by the state as a preliminary to incorporation. They range from a nominal fee, as in Arizona, to a tax of K of i% on the entire authorized capital stock, as in Pennsylvania. In connection with the tax there are included sundry filing fees that increase the total. In them- selves the organization tax and fees are not serious as they have to be paid but once. 3 30. (2) Annual Franchise Taxes The corporate franchise is the primary franchise, that is the right or privilege, granted by the state, of being a corporation, and of doing such things, and such things only, as are authorized by the Charter. 4 The amount of the annual franchise tax, as in the case of the organization tax, varies widely. In Louisiana, Nevada, See Ch. VIII, "Cost of Incorporation." 14 Corpus Juris, } 160; see also i 199. 26 CORPORATE LAW [Bk. I- and some few other states, there is no franchise tax, and from this it ranges up to ]/z of i% on actual values in Penn- sylvania. The tax is a distinct special imposition upon the corporate form a payment for the privilege of transacting business as a corporation. It is in addition to, and entirely separate from, the annual property taxes mentioned in the next section. The franchise tax, while not entirely equitable, is a source of much revenue to the more important incorporating states. 5 31. (3) Annual Property Taxes These are the same in character and amount as the prop- erty taxes paid by individuals, and are therefore justly imposed on corporations. The corporation, however, is at some dis- advantage in this matter, as it cannot evade the taxes in the very facile way that individuals do. This being true, it fre- quently happens that an incorporated business pays a much larger property tax than it did before incorporation, even though its property holdings have not increased. The property tax is, however, the one corporation tax to which no just ex- ception can be taken. It is theoretically at least uniform, equi- table, and proper. 32. (4) State Income Taxes Several states notably Massachusetts, Wisconsin, Con- necticut, and West Virginia impose a tax upon the net incomes of corporations from business transacted and capital invested in the state. In each of these states the tax is upon the income of all corporations doing business in the state, foreign as well as domestic. In West Virginia the tax is an excise tax imposed for the privilege of doing business within the state. Neither Wisconsin nor Connecticut imposes any annual franchise tax upon corporations, but in West Virginia the excise tax is in See { 76. Ch. 4] DISADVANTAGES OF CORPORATE FORM 27 addition to the other usual taxes, making the corporate burden a heavy one. New York has recently imposed a 4^2% tax upon the net income of two classes of corporations, "manufacturing" and "mercantile" corporations. The tax is denominated a franchise tax but a new feature is that it exempts the corporations subject to the act from all personal property taxes. As in other states, the tax applies to foreign as well as domestic corporations and when only a portion of the company's business is transacted within the state the tax is proportionately reduced. 33- (5) State Inheritance Taxes An inheritance tax is now imposed in all of the more im- portant states, and when incorporation is contemplated the in- heritance tax laws of the state of incorporation are an element to be considered, especially in the case where the incorporation is to take place in a state other than the state where the new company is to do most of its business. Under such circumstances there may in some cases be double and even triple taxation by j r j the states. . If the state in which the decedent resided has an inheritance tax, the transfer will be taxable in that state irrespective of whether the stock held by the decedent is stock of a foreign or a domestic corporation. If the corporation is a foreign corporation a second tax may be imposed in the state of in- corporation, depending upon whether that state imposes a tax upon the devolution of stock in a domestic corporation held by a non-resident. In most of the states, stock in a domestic corporation held by a non-resident decedent is subject to the inheritance tax. In New York, stock held by a non-resident decedent is not subject to the inheritance tax unless the corporation holds real property in New York, in which case the stock is subject to a tax for such proportion of its value as the real property 28 CORPORATE LAW [Bk. I- held by the corporation in New York State bears to the entire property of the corporation. The law applies to stock in both foreign and domestic corporations, but excepts from its pro- visions certain classes of corporations, including transporta- tion, moneyed, 6 and manufacturing companies. At the present time stock in a New Jersey corporation which owns real estate in New York, that is held by a decedent residing in Delaware, might be subject to taxation under the inheritance laws of Delaware, New Jersey, and New York. Usually the corporation is required either to collect the taxes or to refuse transfer of the stock on its books until the tax has been paid or a waiver is obtained from the state officer charged with the collection of the tax. 34. (6) Stock Transfer Taxes In New York, Massachusetts, and Pennsylvania a stamp tax of 2 cents on each $100 of face value is imposed on every sale or transfer of stock in the state, whether the cor- poration is domestic or foreign. The statutes of the various states and the rulings thereunder are very similar. In addition to the money fines imposed for failure to comply with the law, the statutes of each state provide that a transfer of stock made without paying the tax cannot be made the basis of any action or proceeding in the state courts. A share of stock sold in one of the three states named and transferred in another is taxable in both jurisdictions. 35- (7) Taxes on Foreign Corporations All corporations having a place of business in states other than that in which they are incorporated, are required to con- form to the local laws regulating foreign corporations. These laws usually require a license to do business for which pay- ment must be made and the payment thereafter of an annual A "moneyed" corporation is a bank, trust company, or other financial institution. Ch. 4] DISADVANTAGES OF CORPORATE FORM 29 tax. In some states the tax imposed on foreign corporations is so onerous that it is economy to organize a small local sub- company to conduct the operations necessary in such states. The taxes imposed on foreign corporations are usually on the same basis as those imposed on domestic corporations, but in most states the franchise or equivalent tax is imposed only on the proportion of capital stock actually employed in state. 36. (8) Federal Taxes 7 The federal taxes which affect corporations are as follows: (a) The income tax (b) Excess profits tax (c) Capital stock tax (d) The stamp transfer tax (e) The inheritance tax These are referred to but briefly in this work. To treat the subject adequately would require more space than is here given to the entire subject of corporate organization and management. 37. Corporation Income Tax 8 The federal tax on net corporate income is from January i, 1922, 12^%. The net income is found by deducting from gross income the allowable deductions. 38. Excess Profits Tax 9 The tax on excess profits will happily cease from January i, 1922. It will have to be paid on the net income for 1921 if this is above $3,000. It is computed on the basis of the income as shown by the returns made for the normal tax. Its complexi- ties frequently require the aid of a skilled accountant. ' See Ch. XLI. "Stock Transfer Taxes Corporate Taxes." 1 See I 389; see also Montgomery on Income Tax Procedure (1922). See | 390. 30 CORPORATE LAW [Bk. I- 39. Capital Stock Tax 10 The capital stock tax is imposed only upon corporations having a capital stock of the fair average value for the pre- ceding year in excess of $5,000, and is a tax of i/io of i% upon such excess. Reports are due and tax payable in July. 40. Federal Stock Transfer Tax u The Federal Revenue Law of 1918 prescribes a stamp tax of 5 cents on each original certificate for $100 of face value or fraction thereof, and on all later transfers of stock a stamp tax of 2 cents on each $100 or fraction thereof. 41. Federal Estate Tax The federal estate tax is an inheritance tax on all estates amounting to $50,000 or more. Corporate stock, like all other forms of property, is subject to the tax, and the law imposes the duty upon the corporation or transfer agent to collect the tax or see that the same is paid or that no tax is due before transferring stock upon the corporate books. REPORTS 42. (i) Local Tax Reports; (2) State Tax Reports Local tax reports, made in connection with the usual prop- erty taxes, are similar to those of individuals. A state tax report or reports are required of corporations, primarily for purposes of taxation, but beyond this they are required to supply a record of the officers and directors of the corporation and such other data as may be deemed necessary. 43- (3) Federal Tax Reports The income tax report is simple to prepare under a well- arranged, modern accountiftg system, but otherwise it is diffi- 10 See { 388. " See { 386. Ch. 4] DISADVANTAGES OF CORPORATE FORM 31 cult and troublesome. The report must be filed on or before March 15, and covers the calendar year ending December 31, preceding, unless the corporation designates the last day of some other month as the closing of its fiscal year and gives proper notice to the collector. In such case the report will cover the fiscal year so designated, and the dates for filing the report and for payment of the tax will be adjusted ac- cordingly. The government regulations require that reports for the capital stock tax be filed by every corporation doing business in the United States. The report must be filed in July of each year and covers the preceding twelve months. Failure or refusal to file either of these reports within the time required by law, or the filing of a false or fraudulent return, renders the corporation liable to a severe penalty and an additional tax to be added to the assessment. 44. (4) Annual Reports In addition to the tax report, many states require the filing of another report, usually in January of each year or other- wise at some specified tune after the annual meeting, giving the names and addresses of the corporate officers and directors, and the location of the principal office in the state. The report is usually simple and is a reasonable requirement, as parties having claims against the corporation or desiring to institute actions against it should have reliable information as to who the officers are and where they can be found. 45- (5) Reports of Foreign Corporations The corporation is usually required to make reports in each state in which it does business. These reports are in most states similar to those required to be filed by domestic corporations. Part II Pre- Incorporation Considerations CHAPTER V SUBSCRIPTION LISTS AND CONTRACTS 46. General 3 In former days the subscription list was regarded as a necessary preliminary to incorporation. It was circulated to determine whether sufficient support could be obtained to justify the proposed incorporation or, if this were already known to be the case, to commit the subscribers definitely and to fixed amounts before the organization was actually under- taken. Now the corporation is usually organized first, property of some kind is taken over, and stock is then sold or subscriptions solicited to raise any needed capital. Under this plan the sub- scription list is of much less prominence and importance than formerly. There are, however, still many cases of incorporation in which the preliminary subscription is employed and is, at times, essential. The farmers of a neighborhood may wish to establish a creamery or a co-operative store; in some growing town the citizens may wish to combine their efforts for the construction of an electric plant, the organization of a bank, the opening of a library, or the establishment of some local industry. In such event the subscription list is circulated as the first step toward the formation of the contemplated corporation. Also in other cases, memoranda or agreements, which are the equivalent of the subscription list, are entered into between the parties interested, and these are the prelimi- 33 34 CORPORATE LAW [Bk. I- nary and definite steps towards the intended corporate or- ganization. 1 47. Nature of the Subscription Contract Prior to the organization of the corporation, the ordinary subscription is merely a continuing proposition from the sub- scriber to the proposed corporation for the purchase of a speci- fied amount of stock. At this stage the subscription is not a complete and enforceable contract, because the other party thereto the proposed corporation has no legal existence, and, until the corporation is formed, the death, insanity, or voluntary withdrawal of the subscriber would cancel the pro- position and thereby terminate the proposed contract. 2 After the corporation is organized and, by either expressed or implied acceptance of the subscriptions to its stock, has completed its part of the contract, the subscription list becomes a binding agreement between the parties thereto, and the corpora- tion may, if necessary, bring suit for specific enforcement. 8 To avoid the possibility of revocation which is characteristic of the ordinary subscription list before its acceptance by the corporation, subscriptions are frequently made payable to trustees, who act for the corporation in the matter, undertaking its organization, and where desirable the collection of the subscriptions in whole or in part. Under such a contract properly drawn, the subscriptions, if unconditional, are binding as soon as made; if conditional, as soon as the conditions are fulfilled.* 48. Effect of Acceptance of Subscription The acceptance of a valid subscription by the corporation not only renders the contract a binding one but also, of itself, 1 See also Book III, Ch. VII, "Stock Subscription System"; and Book IV, Ch. IV, "Sub- scription Lists." " Hudson R. E. Co. v. Tower, 156 Mass. 82 (1892); s. c., 161 Mass. 10 (1894). 1 10 Cyc. pp. 388, 389, 394, n. 57; i Cook on Corp., {5 71, 72, 75. ' Horseshoe Pier, etc., Co. v. Sibley. 157 Cal. 442 (1910). Ch. 5] SUBSCRIPTION LISTS AND CONTRACTS 35 constitutes the subscriber a stockholder of the corporation. If his subscription is made to a trustee for the corporation, he becomes a stockholder as soon as the corporation is organized and his subscription turned in by the trustee. In either case nothing further is necessary to establish him legally in this position nor in the enjoyment of his rights as a stockholder. The delivery of the stock certificates, while a formal recognition of this status, confers nothing that he did not have before, being simply a convenient evidence of his stock interest. These cases in one court in which the subscriber to capital stock has been treated as a stockholder are cases in which the contract between him and the corporation showed that he was a stockholder having complied with the terms of his subscription and all that was required upon his behalf was a certificate evidencing the same. 5 Even though the subscriber never pays his subscription, he is a stockholder from the time of the acceptance of his subscrip- tion until such time as by proper procedure his subscription is ( canceled or forfeited for non-compliance with its conditions. 9 , On the other hand, it is to be noted that the corporation when organized is under no compulsion to accept or recognize the ordinary subscription to its stock. The subscriber is not bound, neither is the corporation, until the contracts completed as to both parties by the acceptance of the subscription by the corporation. 7 If the subscription is made to a trustee for the corporation and is accepted by him, this would make a binding contract between the subscriber and the trustee, but would not bind the corporation until its acceptance of the subscription, expressed or implied. If the corporation accepted the benefit of the trustee's act, it would thereby also accept the trustee's contracts, from which such benefits accrued. The very fact of the organization of the corporation by the trustee, or trustees, 1 Kruse v. Brewing Co., 79 N. J. Eq. 392 (1911). Clark & Marshall, J5 366. 3780, and cases cited. 7 Hudson R.R. Co. v. Tower, '161 Mass. 10 (1894); s. c., 156 Mass. 82 (1892). 36 CORPORATE LAW [Bk. I- might be held to be an acceptance of the subscription contracts which rendered such incorporation possible. Usually, however, the acceptance of subscriptions by the corporation does not enter into consideration, such acceptance following its organization as a matter of course. Litigation may be necessary to compel payment of subscriptions, but not usually to compel their acceptance by the corporation. 49. Exception to Rule in New York In New York, contrary to the weight of authority else- where, the courts do not treat an original subscription to stock in a corporation thereafter to be formed as a continuing offer, but hold that, to be enforceable, it must contain all of the elements of a valid contract at the time it is made. Consequently they will not enforce a simple subscription for stock in a corpora- tion thereafter to be formed, but lay down the rule that, to be enforceable, such subscription must amount to an agreement between two or more parties to form the corporation and to take stock therein, and that only after its formation by such parties, or by someone authorized to act for them in this regard, can the subscription to stock be enforced by the corporation when formed. 8 50. Subscriptions Made as Part of Incorporation Subscriptions made as part of a prescribed statutory form of incorporation are irrevocable as soon as made. 9 This applies to a certificate of incorporation wherein the parties executing it appear as subscribers to designated shares of stock. It also applies to subscriptions made on books or lists opened by com- missioners where this is part of a prescribed statutory form of incorporation. Avon Springs Sanatarium v. Weed, 189 N. Y. 557 (1907); Sanders v. Burnaby. 166 App. Div. (N. Y.) 274 (1915). 2 Clark & Marshall on Corp., { 4Sie; Dupee y. Horse Shoe Co., 117 Fed. 40 (1902); Stevens v. Episcopal Church History Co., 140 App. Div. (N. Y.) 570 (1910). Ch. 5] SUBSCRIPTION LISTS AND CONTRACTS 37 It has been held in some cases that where a statutory form has been prescribed for taking subscriptions, those taken in any other form are not binding. 1 This does not seem reasonable, and there is good authority for the contrary view. 11 After the completion of any subscription agreement by the proper action of both parties thereto, it becomes a simple con- tract and subject to the usual laws of contracts. 51. Subscription Distinguished from Agreement to Buy Stock The subscription to stock must be distinguished from an agreement to purchase stock. 12 In the first instance the sub- scriber becomes a stockholder immediately upon the acceptance of his subscription by the corporation. In the latter case he does not become a stockholder until the consummation of his agreement and the delivery to him of his certificates of stock. A subscription list might be so worded as to be merely an agreement to purchase stock, in which case the subscribers would not be stockholders until they received their certificates of stock." As a general rule the courts construe subscription agreements very liberally in accordance with what appears to be the intent of the parties, but a direct statement that "We, the undersigned, hereby agree to subscribe, etc.," instead of the proper form, "We, the undersigned, hereby subscribe, etc.," might have a very dif- ferent legal effect from that intended. 14 An agreement beginning "We, the undersigned, severally promise and agree to and with each other that we will associate ourselves into a corporation, etc.," was held good in Massachusetts. 15 "Poughkeepsie. etc., Co. v. Griffin, 24 N. Y. 150 (1861); Shelby Co. Ry. Co. v. Crow, 137 Mo. App. 461 (1909). 11 ro Cyc. p. 392, n. 42; Planters, etc., Co. v. Webb, 144 Ala. 666 (1905). 13 Morawetz on Corp., ( 61; 2 Clark & Marshall, 5 382: Wood Harvester Co. v. Jefferson, 71 Minn. 367 (1898); Palais du Costume Co. v. Beach, 143 S. W. 852 (1912). " See Book IV, Ch. IV. "Subscription Lists." " General Electric Co. v. Wightman, 3 App. Div. (N. Y.) 118 (1896); Palais du Costume Co. v. Beach, 143 S. W. 852 (1912). 11 Athol Music Hall Co. v. Carey, 116 Mass. 471 (1875). 3 8 CORPORATE LAW [Bk. I- 52. Form of Subscription Contract Generally the form of the subscription list is of small im- portance if the intent of the parties is clearly expressed. Ex- cept for the difficulty of proof, a verbal subscription, if within the statute of frauds, would be binding. 1 " As a matter of ordinary precaution, however, the subscrip- tion list should be prepared with due regard to form and with a clear presentation of all important details. The name of the proposed corporation, its general purpose, its capitalization, the par value of shares, the state in which it is to be incorporated, and the conditions under which the subscription is made all should be set forth with precision. Enough should be included to prevent any question as to the nature of the sub- scription and the conditions under which it was made. 53. Cautions as to Forms of Subscriptions It is entirely possible to draw a subscription paper so loosely that the subscribers cannot be bound when the corporation is formed and attempts to accept their subscriptions. This is so, for instance, when there is nothing in the subscription agreement to connect the corporation formed with the corpora- tion contemplated by the subscription agreement. A subscrip- tion agreement should identify the proposed corporation with reasonable clearness, and should either name the person or persons who are to form the corporation, or be in its terms an agreement between the persons signing it to organize such a corporation. In this case the corporation should be organized by the persons named. If A, B, and C sign a mere subscription to a corporation to be formed, and afterward E, F, and G, who are not mentioned in the subscription paper, organize such a corporation, there is no necessary connection between the parties, and the newly organized corporation cannot, by merely accepting the subscriptions of A, B, and C, bind them. 17 11 i Cook on Corp., { 52; Peninsula Leasing Co. v. Cody, 161 Mich. 604 (1910). 17 Woods Motor Vehicle Co. v. Brady, 181 N. Y. 145 (1905); Sanders v. Burnaby, 166 App. Div. (N. Y.) 274 (1915). Ch. 5] SUBSCRIPTION LISTS AND CONTRACTS 39 In Massachusetts, Maine, and New Hampshire the sub- scription contract must contain an express agreement to pay. If such a promise is not contained in the agreement, the only remedy is forfeiture of the subscriber's stock for non-payment. 18 Where it is inconvenient to go into full details of the cor- poration and the terms of subscription in the subscription list proper, a general statement or prospectus is frequently prepared and accompanies the list. Where this is done the statements' of this prospectus become a part of the represen- tations upon which the subscriptions are secured, and must be lived up to in all essential details if the subscription is to be held. 19 54. Effect of Material Variation Any material variation from the statements of the sub- scription list, such as a change of capital, or purposes, or location, will release the subscribers. 20 For this reason, only those details should be stated explicitly in the subscription list that have been fully decided upon, any undecided points being either omitted, or stated as undecided, or otherwise so covered that no matter how they are finally settled the subscriptions previously secured will not be affected. For instance, if the name of the proposed corporation has not been finally deter- mined, the list may be headed with any suggested name, as "The Arnold Separator Company," while the body of the document states that the subscriptions are made to the stock "of a corporation to be organized under the name of 'The Arnold Separator Company,' or such other name as may be later determined." Or if the capitalization were not definitely settled the subscription list might fix sufficiently elastic limits by the use of such phrases as "not less" or "not to exceed," according to the conditions. Subscribers to such a list could not plead any voidance of their subscriptions no matter what 18 N.ew Haven Horse Nail Co. v. Linden Spring Co., 142 Mass. 349, 354 (1886). "Southern Insurance Co. v. Milligan, 154 Ky. 216 (1913); Lehman-Charley v. Bartlett, I3S App. Div. (N. Y.) 674 (1909); affd., 202 N. Y. 524 (1911). "> i Cook on Corp.. { 54; 2 Cook on Corp., } 502; Woods Motor Vehicle Co. v. Brady, 181 N. Y. 145 (I90S); Clarksburg Board of Trade v. Davis, 86 S. E. (W. Va.) 929 d9iS). 40 CORPORATE LAW [Bk. I- name or what capitalization, within the limits, was eventually selected. At times individual subscription blanks are sent out instead of a single list. At other times several similar lists are circulated as a matter of convenience. If properly worded to show their common purpose, these separate lists will for all legal purposes be held as a single list, 55. The Common Law Rule It is to be noted that under the common law, unless other- wise specified in the agreement of subscription, the entire capital stock of the proposed corporation must be subscribed before any of the subscriptions are binding and enforceable. 21 In some of the states this has been modified by statute, but unless this has been done the rule prevails, and where it is desirable that subscriptions for a less amount than the entire capital stock shall hold, the subscription list should so specify. It is com- petent for the subscription list to fix this amount at any desired figure and the subscriptions will be binding, provided the other requisite conditions are fulfilled, so soon as the specified amount is secured. Any person competent to contract may make a binding subscription for stock. A subscriber for stock need not neces- sarily be an incorporator of the company, though usually, as a matter of statutory requirement, an incorporator must be a subscriber to the company's stock. One corporation cannot usually subscribe for the stock of another corporation, though it may be permissible in the case of a corporation authorized to hold the stock of other corporations. 56. Underwriting Agreements In the organization of the larger corporations, and more especially those designed to effect industrial combinations, it 11 i Cook on Corp., {( 176-181; Converse v. Gardner Governor Co., 174 Fed. 30 (1909); Myers v. Sturgis, 123 App. Div. (N. Y.) 470 (1908). Ch. 5] SUBSCRIPTION LISTS AND CONTRACTS 41 is usually very important and at times absolutely essential that funds be raised in advance of the time when the corporate securities can be offered for sale, or that there be some positive assurance that the necessary funds will be derived from the sale of these securities when they are ready to be offered. Under such conditions the use of the ordinary subscription agreement would, at the best, be ineffective and in most cases absolutely impracticable. Recourse is then had to the modified form of subscription agreement known as the underwriting agreement. 22 See Book II. Ch. XXVII, "Underwriting." CHAPTER VI CONTRACTS PRIOR TO INCORPORATION 57. Status of Corporation upon Organization When a corporation has been created -by the state, it comes into being free, unencumbered, with no existing business relations, and with no debts, contracts, or obligations of any kind, save those expressed in its charter and in the statute law of the state of domicile. It is not bound by anything done or said before its incorporation unless embodied in its charter. A corporation cannot be bound before it exists, as no one could then act with authority as its agent or representative. 1 After its organization, the corporation may recognize or accept any proffered contracts it sees fit, and this applies to contracts made on its account before its incorporation. Its acceptance of such a contract may be expressed or implied. If the corporation takes the benefit of the contract, it is liable thereon without any express recognition or formal acceptance. 2 For example, if offices had been leased for the corporation before its incorporation, and the corporation when organized occupied the offices, it would be liable on the contract without further acceptance. If the corporation did not occupy the offices but by a proper resolution recognized the contract and assumed the rent, it would be liable. If it neither occupied the offices nor assumed the lease, there would be no acceptance either expressed or implied and the corporation could not be held. The whole matter rests in its discretion. 8 1 See I 63; see also 3 Cook on Corp., 707; Oakes v. Water Co., 143 N. Y. 430 (1894); Federal, etc., Co. v. Loeb, 147 App. Div. (N. Y.) 737 (1911). 2 Robins v. Ry. Co., 100 Me. 496 (1905); In re Ballou, 215 Fed. 810 (1914). 3 Bond v. Atlantic Terra Cotta Co., 137 A. D. (N. Y.) 671 (1910); Sheator Tel. Co. v. Tel. Co., 217 111. 577 (1905); Whitney v. Wyman, 101 U. S. 392 (1879); Martin v. Remington- Martin Co., 9S A. D. (N. Y.) 18 (1904). 42 Ch. 6] CONTRACTS PRIOR TO INCORPORATION 43 In Massachusetts and in Missouri the courts hold that a corporation cannot, by adoption or otherwise, ratify a contract made when it was not in existence by one who assumed to act as its agent. It may, if its directors see fit, make a new contract on the same terms, but this is a new contract and must be complete as a contract in itself. 4 A contract made prior to the incorporation might amount to an offer to the corporation which it could accept. 5 58. Status of Contracting Parties Contracts are continually entered into by incorporators, promoters, or trustees for and on account of unorganized cor- porations. These contracts are entered into on behalf of the corporation and in its interests, but the party who enters into any such contract is himself liable in the absence of an express agreement to the contrary until the assumption of the contract by the corporation. 6 Then, if it was understood that he was acting in the interests of the corporation, the party directly contracting is relieved of liability, the corporation taking over the liability in his stead. If, however, there were no such understanding the party who originally made the contract would be responsible, even after the contract was taken over by the corporation. 7 For example, if offices are leased for the use of a corporation about to be formed, with the clear understanding that the party making the lease is acting for the unorganized corporation, such party is personally liable and', if the corporation fails to assume the lease, can be held for the full amount, but so soon as the contract is assumed by the new corporation he is released. If, however, the lease were taken without a clear understanding that the party was acting for .the corporation, he would not be * Pennell v. Lothrop, 191 Mass. 357 (1906); Whiting & Sons Co. v. Barton, 204 Mass. 169 (1910). * Holyoke Env. Co. v. U. S. Envelope Co., 182 Mass. 171 (1902). 6 i Machen on Corp., { 358 el seq. i Case Mfg. Co. v. Soxman, 138 U. S. 431-437 (1891); Strause v. Richmond Woodworking Co., 109 Va. 724 (1909). 44 CORPORATE LAW [Bk. I- relieved by the mere fact that the corporation took over the lease, but would still be liable and, should the corporation fail to pay its rent, might be called upon to make good the deficiency. For this reason, in making contracts for the benefit of an unorganized corporation, the fact that they are being made for such proposed corporation should be clearly recognized and expressed. The parties making such contracts should also recognize their own liability in the matter and, if there is any uncertainty as to the ultimate organization of the corporation or its acceptance of the contracts, should make them dependent upon the organization of the corporation and its acceptance of the contracts, or otherwise be prepared to assume the respon- sibility themselves. 8 59. Agreements among Incorporators There is another class of agreements relating to the un- organized corporation of a very different nature. These are the understandings or agreements among the incorporators or other interested parties which define the nature of the proposed corporation, its purposes, and often the details of its organization and management. Among the parties these agreements are perfectly proper and legitimate, but they affect the corporation only so far as they are incorporated in its charter or by-laws when these are drawn. It is to be borne in mind that provisions may be incorporated in the charter or made part of the by-laws in pursuance of a contract or as a consideration for a contract, in such wise that their subsequent alteration or repeal can be effected only by consent of the interested parties. One partner may agree to the incorporation of the partnership business on condition that certain provisions be embodied in the by-laws, the maintenance and observance of such provisions constituting part of the consideration for the transfer of the partnership property. Such by-law provisions, properly incorporated and duly adopted, 8 I Machen on Corp.. 5 361 Ch. 6] CONTRACTS PRIOR TO INCORPORATION 45 cannot be revoked without the consent of all parties concerned. 9 No by-law can be repealed so as to violate or impair a vested right. Often agreements in regard to incorporation are mere verbal understandings. Usually, if not carried out, these only result in the refusal of the aggrieved party to move further in the matter, such agreements not ordinarily furnishing sufficient basis for litigation. Even formal agreements between promoters as to the subject matter of a charter can rarely be specifically enforced, and the only recourse of the aggrieved party is a refusal to participate in the subsequent organization of the corporation or, if damages can be shown, to bring a suit against the offending parties for their breach of contract. 11 60. The Promoter's Function A generally approved definition of a promoter is as follows: A promoter is a person who brings about the incorporation and organization of a corporation. He brings together the persons who become interested in the enterprise, aids in procuring subscriptions, and sets in motion the machinery which leads to the formation of the corporation itself. . . . A person who procures subscriptions and aids in organizing the company and frames the papers and manages the procuring of options and the vesting of title, is a promoter, even though he is also a subscriber. 12 A late work says of promotion : All business enterprises owe their existence in the beginning, to the imagination of some one man. Very frequently he co- operates with others, so that the original plans appear to be the results of the joint efforts of a group of men. The American Kent v. Quicksilver, etc., Co., 78 N. Y. 159; Lowenthal v. Rubber, etc., Co., S3 N. J. Bq. 440. 10 Wright v. Knights of the Maccabees, 196 N. Y. 391 (1909). 11 i Machen on Corp., 410; Rudiger v. Coleman, 112 A. D. (N. Y.) 279 (1906). "2 Cook on Corp., {651. See Book II, Ch. XXI, "Promoters," Ch. XXII, "The Promoter's Legal Status." 46 CORPORATE LAW [Bk. I- Telephone and Telegraph Company owes its existence to the imagination of Alexander Graham Bell and his enthusiastic confidence in the commercial adaptability of the telephone, but the success of the company in its earliest years was due quite as much to the financial skill of another man, the advertising ability of still another, and the power of organization of yet another. In one sense, Bell was the promoter of the telephone company because he conceived the instrument and foresaw its economic significance. But in another sense, his associates are all to be looked upon as promoters because their united efforts were required to launch the new undertaking. 13 tii-i /!lc\iiil }> ! '-. od 61. Promoters' Contracts The general doctrine that no one is authorized to contract for a corporation before it is formed applies to all contracts with and by promoters. The promoter is himself liable on these precorporate contracts, unless otherwise expressly pro- vided, but the corporation is not. 14 For example, as is frequently the case, the promoters of an enterprise may agree with an attorney for its incorporation, authorizing him to attend to the whole matter, including dis- bursements, preparation of seal, printing, etc.; the amount of his professional fee being agreed upon in advance. On the organization of the corporation, its directors might, if they saw fit, disclaim the whole matter and the attorney would have neither recourse nor claim against the corporation on account of his contract with the promoters. The corporation having utilized his legal services in its incorporation, would probably be held for a fair fee and for the necessary disburse- ments, such as the state fee, notarial charges, filing fees, etc. But such claims would have to be based on their own merits, not on the terms of the agreement made with the promoters. That agreement would have no standing as against the cor- poration, and should this latter reject the seal, printing, etc., u 2 Dewing on Finan. Policy of Corp., p. 4. 14 Bank v. Church Federation, 129 Iowa 268 (1906); Munson v. Syracuse, etc., R. R. Co., 103 N. Y. 59 (1886); Bond v. Atlantic Terra Cotta Co., 137 App. Div. (N. Y.) 671 (1910). Ch. 6] CONTRACTS PRIOR TO INCORPORATION 47 the attorney would have no ground to proceed against the corporation therefor, but must look to the promoters. 15 The most difficult question arising under contracts with promoters relates to the sale of property to the corporation. It is a matter of almost daily occurrence for promoters to dis- pose of property to corporations organized by them for the express purpose of taking over such property. This some- what complicated subject is discussed in detail in a later chapter. 16 62. Option Contracts In the formation of corporations, and especially in the formation of combinations, it is frequently necessary that op- tions be secured in advance of the actual incorporation. As these options may be, and often are, absolutely essential to the enterprise, they must be secured before the corporation is formed and frequently involve very considerable expenditures of money. Notwithstanding the importance of these contracts and their peculiar nature, they fall under the general rules gov- erning precorporate contracts. If accepted, they become the contract of the corporation; if rejected, the corporation cannot be held. If the corporation refuses to take over any such option contracts, the party obtaining or holding them would have no claim for compensation or for damages on account of any payments made by him thereon or in connection therewith. He might have some claim against his associates if they made any promises to him in regard to the options or authorized him to procure them, for the joint account, but the corporation itself could not be compelled to accept them, nor could it be held in any way except by its voluntary consent. 17 "Re Empress Engineering Co.. L. R. 16, Ch. D. 125 (1881); Weatherford Ry. Co. v. Granger, 86 Texas 350 (1894); Taussig v. St. Louis, etc., Ry., 166 Mo. 28 (1901); Bank v. Eckels, 191 Pa. 372 (1899). See Book II, Ch. XXII, "The Promoter's Legal Status." " See Book IV, Ch. X, "Options and Voting Trust Agreements." 48 CORPORATE LAW [Bk. I- 63. Trustees' Contracts When the organization of a corporation is contemplated, not infrequently a trustee, or trustees, will be selected to act for the inchoate corporation. Some arrangement of the kind is necessary where subscriptions to the stock of the corporation are to be made binding before its organization. Also it is usually advisable to have definite parties in charge of the matter who have power to act for the subscribers. Such trustees frequently collect payments on subscrip- tions, make disbursements in the interest of the new enter- prise, and in some cases actually carry on the undertaking until such time as the corporation may be advantageously organized and put in control of the going concern. No matter how far such trustees may have carried the corporate affairs nor to what extent they may have contracted in the interests of the corporation, they have the same in- dividual liability on these contracts and the same inability to force them on the corporation, as in the case of any other precorporate contracts. The coign of vantage occupied by the trustees is found in the fact that they are in control of the organization, and where, on behalf of the corporation, contracts of any impor- tance have been entered into, or disbursements have been made, or obligations have been incurred by them, they will see that these are properly assumed by the corporation before its control passes from their hands. Then, if these contracts have been entered into in proper form so that the assumption by the corporation releases the trustees, these latter, barring fraud, are thereafter absolutely free from any liability on account of their precorporate undertakings. 18 64. Effect of Failure to Incorporate When contracts are entered into in expectation of the formation of a corporation and on its behalf, the trustees' See S 58. Ch. 6] CONTRACTS PRIOR TO INCORPORATION 49 status, if the corporation fails of incorporation, depends upon the nature and condition of the contract. A subscription to its stock, no matter how irrevocable, would be terminated; if payments had been made thereon to a trustee, any unexpended amount might be reclaimed; and if the trustee were to blame for the failure to incorporate, he might be responsible for the portion expended as well. Other contracts, if clearly made on behalf of the proposed corporation, would in most cases be terminated. If not clearly so made, the parties acting for the corporation might be held to specific performance or for damages for non-performance. If the contracts were made with the distinct understanding that they were for the benefit of the proposed corporation, the parties acting for the unor- ganized corporation could not insist on performance for their own benefit. Subscribers may under some circumstances be held liable as partners for expenses incurred if the attempted incorpora- tion is not effected. Thus where a projected incorporation failed the court said: "Under the facts disclosed in this case, the corporation had no existence; there was simply an im- matured intention of the parties to form a corporation . . . there being no responsible principal, the associated parties must be held liable as partners." 19 In Illinois, Mississippi, and some other states the statutes provide that the incorporator shall be held personally liable where the incorporation is incomplete. 21 19 Furniture, etc., Co. v. Crawford, 127 Mo. 356 (1894); Meyer v. Brunson, 88 S. E. fS. C.) 359 (1916); Bank v. Sheldon. 86 Kan. 460 (1912). 20 Ragland v. Doolittle, 100 Miss. 498 (1911); Richardson Fueling Co. v. Seymour, 235 111. 319 (1908). CHAPTER VII >mj;i-/.- ''.I'-in* ->r{t ii WHERE TO INCORPORATE 65. General In the United States, businesses hampered by the fact that the laws regulating the conduct of business vary as we cross the imaginary lines that separate state from state. If the corporation laws and taxes were uniform in every state of the Union, or if the whole matter were regulated by gen- eral federal laws, the best location for any particular cor- poration could easily be determined. It would then, as a matter of course, be organized in that state in which the -principal operations were to be carried on or in which its headquarters might most conveniently be located. There is, however, great variation in the cost of incorpora- tion in different states, also in the rates and methods of taxa- tion after incorporation. The general requirements and regu- lations imposed on corporate operations also differ widely. Owing to the material differences in the costs, regulations, and requirements of the several state laws, taken in connection with the fact that a corporation organized in one state may, under the restrictions imposed on foreign corporations by other states, do business in these states, the selection of the place of incorporation frequently becomes a balancing of the comparative advantages and disadvantages of the available states. The low taxes of one state will be weighed against the better corporation laws of another; the liabilities incurred in a convenient state with the freedom therefrom in another less convenient state; the benefit of incorporation under desir- able laws in an "outside" state and consequent burdens hi the "operating" state, as against direct incorporation in this 5 Ch. 7] WHERE TO INCORPORATE 51 latter; or the privileges allowed by one state as against the immunities enjoyed under the laws of another. lot -3>rfJ fo ,.: . ixftb ofe- /vrif 66. Domestic Incorporation Within the boundaries of the state by which it is chartered a corporation is a domestic corporation; outside these bound- aries it is a foreign corporation. Within its own state a cor- poration has certain recognized powers and privileges as a matter of right; outside it has only such powers and rights as may be accorded foreign corporations by the laws or customs of the particular state. These regulations as to foreign cor- porations vary greatly in the different states. In some, foreign corporations are discriminated against, while in others, upon compliance with the prescribed formalities, foreign corpora- tions have the same status as domestic corporations. As a rule a corporation should be organized in that state in which its principal operations are to be carried on, and this rule should not be departed from unless to gain some distinct advantage. At times, however, there may be weighty reasons for incorporating in an outside state. Also it often happens that the business of a corporation must be conducted in a number of different states, in which case it is domiciled in one state and thereafter transacts its business in the others as a foreign corporation. The selection of the home state then becomes purely a question of expediency. 1 67. Foreign Incorporation A corporation is not' a citizen of the United States and has no claims to the privileges and immunities of citizenship under the Constitution. 2 It is an artificial creation of the state in which it is incorporated, and in that state is endowed by common and statute law with certain rights, powers, and immunities. It is also usually allowed to carry on its oper- 1 See H 224, 225. Paul v, Virginia, 8 Wall. 168 (1868). 52 CORPORATE LAW [Bk. I- ations in other states, with all the powers and privileges it en- joys in its home state. 8 These other states may, however, if they so desire, ignore the fictitious personality of the foreign corporation, refuse it recognition, debar it from initiating liti- gation in the state courts, consider it a partnership if litigation be brought against it, or even entirely prohibit its corporate operations within the state except in so far as they may be permitted by the constitutional provisions regulating interstate commerce. 4 Article I of the United States Constitution gives the federal government the sole authority "to regulate commerce with foreign nations, and among the several states and with the Indian tribes." Consequently, attempts of the state authori- ties to prevent or impose restrictions on corporations taking orders in or shipping goods into a state have been held un- constitutional. Generally, however, no discrimination is exercised against the foreign corporation. In most, if not all the states, laws will be found providing for certain fees and other require- ments as a prerequisite to the exercise of the corporate rights by foreign corporations within the state, but upon compliance with these demands they are admitted freely and are usually accorded all the rights and privileges of domestic corporations. Some states have even favored "the stranger within the gates," as in New York, where for many years domestic cor- porations were subjected to high fees, burdensome reports, and possible liabilities, which were not imposed upon foreign corporations doing business within the state. As a conse- quence the citizens of New York when desirous of incor- porating a local business or enterprise would resort to other states for the purpose, and the corporation so organized would thereafter do business in New York as a foreign corporation, Tootle v. Singer, 118 Iowa 533. 536 (1902); Lancaster v. Amsterdam Improvement Co., 140 N. Y. 576 (1894). 4 2 Morawetz on Corp., 9653; Ducat v. Chicago, 10 Wall. 410 (1870); Pembina Mining Co. v. Pa., 125 U. S. 181 (1888); Pensacola Tel. Co. v. W. U. Tel. Co., 96 U. S. i (1877). Ch. 7] WHERE TO INCORPORATE 53 and this though all the parties interested resided in the state and all the corporate business was transacted there. This practice gave rise to litigation to determine the right of citizens to incorporate elsewhere when the corporate busi- ness was to be conducted in the state, but the decisions were uniformly and unreservedly in favor of such right. 5 In other states the same question has arisen and has been so uniformly decided in the same way that the principle may be regarded as firmly established. 6 In some states conditions of so onerous a nature exist as to render foreign incorporations most desirable, as for instance the double liability of Minnesota, which is imposed upon the stockholders of certain corporations when organized under the laws of the state. Under ordinary conditions the stockholders of a foreign corporation doing business in the state escape this double liability altogether, being subject only to such liabilities as are imposed by the corporation laws of the state of organization. 7 68. The Liability in California In this connection it is to be noted that the state of Cali- fornia, in which a special liability is imposed upon stockholders of domestic corporations, has sought to extend this same liability by statute provision to the stockholders of foreign corporations doing business within the state. This liability has been sustained in two decrees of the Supreme Court of the United States, in one instance as against the California stock- holders of a Colorado corporation doing business in Cali- fornia, and in the second case as against a New York stock- holder of an Arizona corporation doing business in California. In the first case, however, the corporation was organized in 6 Merrick v. Van Santvoord, 34 N. Y. 207 (1866); Demarest v. Flack, 128 N. Y. 205 (1891), Lancaster v. A. I. Co., 140 N. Y. 576 (1894). People v. Fidelity Co., 153 111. 25 (1894); Haskins v. Kelly, 77 Kans. 155 (1908); Saltmarsh v. Spaulding, 147 Mass. 224 (1888). 'Bank v. Hall, 35 O. St. 158 (1878); Canada Southern R. Co. v. Gebhard, 109 U. S. 527 (1883); Risdon I. & L. Works v. Furness, I K. B. 49 (1906). 54 . CORPORATE LAW [Bk. I- Colorado, mainly by citizens of California, for the express purpose of doing business in California, and this purpose, with unusual and perhaps unnecessary frankness, was specifi- cally set forth in the charter. 8 In the second case the charter recited that the corporation was formed to carry on business in Arizona and California, and the defendant prior to the incorporation had signed a writing reciting the intent of the subscribers to form a cor- poration in Arizona for the purpose of acquiring land in Cali- fornia and locating a hotel thereon. While not questioning the principle that the corporation could not without authority from the stockholder make him answerable in a way not con- templated by the charter, the court in the latter case held that, on the facts, the stockholder had assented to the doing of business in California and was therefore bound. 9 69. Risks of Doing Business in Foreign State Without Authorization It may be stated as a general rule that if corporate busi- ness of any importance is to be carried on in a foreign state, all the requirements of that state in regard to foreign cor- porations should be complied with as a matter of business policy and expediency. In some states severe fines are im- posed on corporations doing business without a license, though the usual penalty is the refusal of corporate recognition by the foreign state. The corporation may, however, still carry on business within such foreign state, its property is safe from confiscation, and it cannot be prevented from bringing suit in all proper cases in the United States courts in that state. Beyond this, however, it has no status. It cannot enforce a contract or collect a debt in the state courts. Where, however, as in Michigan, Missouri, and several other states, the statutes declare all contracts made by unauthorized foreign corpora- 8 Pinney v. Nelson, 183 U. S. 144 (1901).* Thomas v. Matthiessen, 232 U. S. 221 (1914). Ch. 7] WHERE TO INCORPORATE 55 tions to be void, no action is maintainable upon such contracts even in the federal courts. 10 In Florida it has been held that, if sued, an unauthorized foreign corporation may be treated as a partnership and its stockholders be considered as part- ners." In addition to the restrictions and penalties imposed upon unauthorized corporations, as corporations, many states make the officers and agents acting for the corporation within the state liable to heavy penalities, and five of the western states make the officers and agents of the corporation jointly and severally liable in any and all contracts of such corporation made within the state during the time that the corporation was in default. 70. Cheap Incorporation Resort to outside incorporation on account of its cheapness is legitimate but not always wise. The cheap states have their advantages, but the excellence of their corporate regu- lations does not figure among these. Nor is the status of their incorporations as a class entirely desirable for reputable organizations. Occasions will occur when temporary or experimental in- corporations are desirable, or where the conditions are such that the cheapest incorporation must be made to serve, or where the laxity of corporate regulation is regarded as advan- tageous. Then the cheap location will be sought. Speaking generally, however, the ease and cheapness with which incorporation may be secured in these localities draw to them the unsubstantial enterprises, illusive undertakings, and fraudulent schemes that so frequently adopt the cor- porate guise for their dubious careers. These, flocking to the cheaper states, give bad repute to their incorporations, and 10 Despres, Bridges & Noel v. Zierleyn, 163 Mich. 399 (1910); Parke Davis & Co. v. Muller, 245 Mo. 168 (1912); Haynes Wheel Co. v. Am. Distributing Co., 257 Fed. Rep. 881 (1919). 11 Taylor v. Branham, 35 Fla. 297 (1895). 56 CORPORATE LAW [Bk. I- the very fact of organization in one of these states is a cir- cumstance requiring explanation and tending to prejudice the experienced investor. In other words, the corporation is in bad company and is likely to suffer the usual results of such association. An even more material objection to the states of cheap incorporation is found in the fact that their corporation laws are crude, incomplete, and for the most part unadjudicated. Nor is there any reasonable assurance of the permanency of the existing laws. Obviously they have been compiled hastily and without requisite care and consideration, and they are liable to be amended or altered at any time with equal haste and lack of judgment. The possibilities in this direction are illustrated by the corporate career of West Virginia. Prior to 1901, West Virginia had a virtual monopoly of the cheap in- corporation business. Its rates were low and its requirements simple. Incorporations flowed to it in a steady stream and its revenue therefrom was large and very profitable. In 1901, however, without previous warning and without obvious rea- sons beyond an ill-judged avarice, the state legislature raised the corporate fees and taxes materially and made them com- plicated as well as burdensome. The result was the practical destruction of the incorporating business in West Virginia. Most of the outside corporations already in the state rein- corporated elsewhere, new incorporations ceased to come, and West Virginia is no longer considered an available resort for incorporators from other states. 71. Reputation of Different States Each of the incorporating states has a general reputation in corporate matters. This primarily arises from the character and operation of its corporate legislation and from the security afforded thereby to corporate investors and creditors, but is directly derived from the character of the corporations or- ganized under its laws. Ch. 7] WHERE TO INCORPORATE 57 This reputation is of much importance to corporations in- tending to offer their securities to intelligent investors. In the cheaper localities, on account of this cheapness and the accom- panying laxity of the corporate laws, such reputation is dis- tinctly bad. The mere fact that a corporation is organized in Arizona or Nevada is sufficient to put experienced investors on their guard and renders the sale of corporate securities difficult. Among the more moderately priced incorporating states, Maine stands well and is resorted to by many eastern corpo- rations. Delaware has a fair reputation and, with its moderate organization fees and annual taxes, is a popular state for out- side incorporations. New Jersey was at one time the most popular state in the Union for outside incorporations of large capitalization, but in 1913 the legislature passed certain laws affecting corpora- tions known as the "Seven Sisters Acts," which prohibited holding corporations, and otherwise made restrictions which greatly hampered New Jersey's business of incorporation. New Jersey felt the change severely and has recently restored to good standing the holding corporation and the subsidiary company. These are now lawful, provided their effect is not to "substantially lessen competition," or to "restrain trade," or to "create a monopoly." Massachusetts stands high, on account of the conservatism of her laws. Pennsylvania is greatly handicapped by the com- plications of her corporation laws, and the high fees, but stands well, as do also Illinois and other important states lying between. New York under its present corporation laws ranks high. 72. Liabilities Imposed in Different States When the selection of a state for incorporation is under consideration the special liabilities attaching to directors and stockholders of a corporation are matters for careful investiga- tion. The unusual stock liabilities found in Minnesota and California are very serious, if not insuperable, objections to 58 CORPORATE LAW [Bk. I- incorporation in these states. In the cheap localities the usual liability on unpaid stock exists, but there are no special liabili- ties of either directors or stockholders. In the more important incorporating states stockholders generally have no liabilities save on unpaid stock, though in Massachusetts, New York, and a few other states there is a stockholders' liability to laborers employed by the corporation. Also in Idaho, Minnesota, and some other states failure to observe certain requirements as to corporate organization and procedure may involve stockholders in liability; and in a num- ber of states the legislatures have re-enacted the common law liability of stockholders which exists in all states for divi- dends or other disbursements to the stockholders which im- pair the capital stock. In most of the states directors are held liable only for negligence or direct fraud. 73. Protection of Minority in Different States The protection of minority interests is at times of very great importance. It could hardly be satisfactorily secured in any state where special charter provisions are not permitted, though hi some states where such provisions are not allowed, the right to cumulative voting is effectually secured by the constitution or the statutes of the state, and the minority is to that extent protected. In Delaware, New Jersey, and New York protection may be secured by charter provisions. In Maine it may be had only by by-law enactment, which, as the by-laws are subject to. repeal by the majority, is practically no protection. 12 74. General Rules for Selection of State Usually the selection of the place of incorporation will be determined by the particular conditions. The more important of the few general rules that can be given are as follows : See Ch. LVIII. "Protection of Minority." Ch. 7] WHERE TO INCORPORATE 59 1. A corporation having but one plant or place of busi- ness, in which all or the greater part of its capital is involved, should be incorporated in the state where that plant or place of business is located. 2. Any large corporation, or industrial combination, formed to transact business or operate plants in a number of states will, for the reasons already given, find incorporation in Dela- ware advantageous, while Maine also is favored for incorpora- tions of this kind. 3. Temporary incorporations, some few close corporations, purely speculative corporations, incorporations of doubtful stability, and all other corporations desiring the maximum of capitalization with the minimum of expense and restriction, will naturally gravitate to the bargain-counter localities where the cost of incorporation is nominal. CHAPTER VIII COST OF INCORPORATION 75. General The direct expenses of incorporation are the initial organ- ization taxes paid the state authorities, the incidental fees for filing and acknowledgments, fees paid to counsel, and the cost of the corporate equipment. Thereafter the expenses are presumably the same as for an unincorporated concern, save for the annual franchise tax and possibly an increased property taxation that may result from the greater difficulty of evasion under the corporate form. The incidental fees are usually trifling. The initial state fees and the subsequent annual taxation are more serious. As these differ greatly in the various states, however, only a general consideration of the subject can be undertaken here. 76. Organization Fees and Annual Taxes In deciding upon a locality for incorporation the matter of fees and taxes should not be given undue importance. In many cases really important advantages are sacrificed for the sake of immaterial savings in fees. Unless the saving is con- siderable, it is rarely expedient to incorporate in a foreign state for this reason alone. The following tables give the states most utilized for general incorporation purposes. It is to be noted that all such tables of comparative expenses are misleading without some explanation. For instance, the annual taxes of the following table are based on the supposi- tion that in each case the entire stock of the corporation is issued and outstanding. Also the annual taxes as given are exclusive of the usual tax imposed on any real or personal 60 Ch. 8] COST OF INCORPORATION 61 COMPARATIVE TABLE OF ORGANIZATION EXPENSES Including Taxes and All Filing and Incidental Fees Capital Stock of Company New Jersey New York Delaware Maine South Dakota $ 1,000 $ 35 $ 45 $ 25 $ 27 $ 15 5,000 35 45 25 27 15 10,000 35 45 25 27 i5 25,000 35 47-50 25 67 i5 50,000 35 60 25 67 20 100,000 35 85 25 67 2O 500,000 no 285 65 67 25 1,000,000 2IO 535 "5 117 25 5,000,000 I.OIO 2,535 265 5i7 "5 10,000,000 2.OIO 5,035 1,015 1,017 155 COMPARATIVE TABLE OF ANNUAL FRANCHISE TAXES $ I.OOO $ I $ 5 $ 5 None 5,000 5 5 5 ii 10,000 IO Annual 5 5 it 25,000 50,000 25 50 Income Tax 5 10 5 5 " 100,000 IOO IO IO ** of 500,000 500 25 So 1,000,000 1,000 4/2% 50 75 " 5,000,000 4/300 150 275 " 10,000,000 4,250 275 525 " property held in the state, which is taxed in all respects as if owned by an individual. In New York the annual tax has been superseded by an annual income tax of 4/^2% on the net income as reported in the federal income tax report. In the table as given the usual incidental expenses of each state have been included as part of the organization tax. These incidental fees vary. In New York they amount approximately to $35> m New Jersey $10; in Delaware $15; in Maine $17; in South Dakota $3. In Arizona these fees would amount to from $20 to $30. . 62 CORPORATE LAW [Bk. I- The comparative cost of Incorporation comes up for con- sideration only when foreign incorporation is contemplated. In all such cases the cost of keeping up a state office and agent in the selected state is to be added to the usual expenses. This would vary from $25 to $50 annually for corporations of moderate capitalization, and usually includes assistance in holding annual meetings in the state and such attention to state reports as is demanded by the local law. 77. Annual Franchise Taxes It is to be noted that the annual franchise tax in New Jersey amounts to a very considerable sum. The annual franchise tax in Maine and in Delaware is moderate. In the District of Columbia, Illinois, North and South Dakota, and some other of the western states, there is no annual franchise taxation. Connecticut and Wisconsin have no franchise tax but have an income tax which applies to the income of corporations. In considering the question of cost, it is to be remembered that foreign corporations are usually required to pay license fees and taxes in the states in which they do business, and often foreign incorporation merely adds the cost of the outside incorporation to the taxes that cannot be avoided in the state in which the corporation conducts its operations. In some cases, however, a foreign incorporation may save onerous local taxation, as in the New York case of People, etc. v. Feitner, 1 where debts due the company from parties outside the state were held taxable in the state, as was also personal property generally regardless of its situs. At that .time foreign incorporation would have saved the corporation over $30,000 per annum. At present, however, the New York income tax on corporations has super- seded the taxation then in force, and personal property and accounts receivable, as such, are not taxed. 1 54 App. Div. (N. Y.) 217 (1906). Ch. 8] COST OF INCORPORATION 63 78. Effect of Bond Issue Where a corporation is organized to take over a business or property, it is often possible and frequently distinctly advan- tageous to issue bonds in part payment for the property taken over. The necessary capital stock of the company is thereby reduced by just the amount of this bond issue, and the state fees and the state taxation thereafter are also proportionately less. Also in many states, the corporation in rendering its statement of taxable property is allowed to deduct any out- standing indebtedness. The bond issue is an entirely legitimate indebtedness and in these states may be deducted from the taxable property of the corporation in ascertaining the basis of taxation. This law was sustained by the decision in an extreme case, 2 where the corporation under consideration had an outstanding bond issue of $2,250,000, an amount far in excess of its total capital stock, and at least twice the amount of its actual assets. In this decision the court said: This indebtedness must in the nature of things be taken into consideration in arriving at the value of the capital of the relator. And when it is seen that the indebtedness of a corporation is double the amount of all its assets, it follows, upon the system adopted by the state for the assessment of corporations that the actual value of the capital of such a corporation is zero. In New York the tax on the corporate income has taken the place of the tax on the personal property of corporations, but in other states the reduction of taxable assets by issuing bonds instead of stock can still be effected. In reckoning the federal income tax, the interest paid on outstanding bonds would be a legitimate deduction and would cut down the income subject to taxation. It would have the like effect in those states where corporate income is taxed. 8 1 People, etc. v. Barker, 139 N. Y. 55, 63 (1894). See also i 93. 64 CORl'ORATE LAW [Bk. I- 79. Effect of Location of Place of Business In some states a corporation is taxed on personal property in the place where its principal place of business is located, and this place of business is fixed by its charter. This formerly obtained in the state of New York. 4 It is possible that in other states this plan of evading taxation may still be effective, as it was in New York for many years. 5 80. Avoiding Fees and Taxation As stated elsewhere, it is usually advisable for an incorpora- tion to be taken out in that state where the principal business is to be conducted. At times, however, the incorporating fees are so excessive that the corporation is forced to resort to another state where the fees are less onerous, doing business in its own state thereafter as a foreign corporation. For instance, had the Steel Trust incorporated in Pennsylvania, which would naturally have been its home state, its initial fees would have amounted to over $3,500,000. In the state selected, New Jersey, these fees amounted to but $220,000. Incorporation in a less expensive state is the most obvious method of avoiding excessive state fees, where practicable. Conditions may exist, however, which fix the state of incorpora- tion despite the question of fees; and where the fees are high, the details of incorporation should then be so adjusted as to reduce these fees and the annual taxation thereafter to the lowest possible figure. One ill effect of income taxes, both state and federal, is to penalize careful management, and as a consequence among those corporations having large incomes, advertising, salaries, and other outlays have been largely increased as a means of reducing the net income subject to taxation. There is a limit to this, but salaries have undoubtedly been 4 Union Steamboat Co. v. City of Buffalo. 82 N. Y. 351 (1880). 6 At present, with most New York corporations the new 4}^ % income tax, uniform in all parts of the state, makes this form of evasion impracticable. Ch. 8] COST OF INCORPORATION 65 awarded with greater liberality since the income law was adopted. Where the corporation is not a close corporation, but persons outside the corporation own part of its stock, such increase of salaries may defraud them of their rightful dividends. In some states taxes are arranged upon a sliding scale, depending upon the rate of dividends paid. Where this is true, close corporations not infrequently reduce their dividends by the disposal of profits as salaries, instead of allowing these profits to accumulate and be distributed as dividends. In many states manufacturing corporations are either entirely released from the payment of state franchise taxes or are granted a more liberal basis or rate. Such exemption would naturally be claimed as far as possible. 81. Double Incorporation to Avoid Fees and Taxation A more intricate method of avoiding taxation sometimes followed is the organization of a company with the desired name, purposes, and capitalization in some state where taxa- tion is moderate, as Delaware, Maine, South Dakota, or Arizona. Stock is issued for property in apportionment of interests and for other purposes as necessary. This is the actual corporation. A small operating company is then incorporated in the state in which the business is really to be conducted, with the same name and purposes, but with a nominal capitalization, possibly only i% of that of the larger corporation. The smaller cor- poration then acts as the local agent of the larger corporation, under such arrangement as the particular conditions indicate, the larger corporation not appearing actively in the conduct of the business. If the small corporation is to have an entirely independent existence, with officers and stockholders distinct from those of the larger company, it is usually arranged that it shall make no profits, all these being diverted to the larger corporation. If this separate existence is not necessary, the stock of the smaller See Ch. LX, "The Management of Close Corporations." 66 CORPORATE LAW [Bk. I r corporation is held either by the larger corporation or by the stockholders of the larger corporation in due proportion. The officers of the smaller corporation are then usually the same as for the larger corporation, and the relations between the two are very close. It is obvious that organization fees and taxes are by this device largely avoided, and that both state and local taxation thereafter are materially lessened if not almost entirely evaded. The general plan is, however, difficult and complicated and requires the assistance of able counsel for its proper execution. 82. Legal and Illegal Methods of Avoiding Taxation The whole system of taxation is unsatisfactory and in- equitable. Many corporations make false returns, shift cash accounts, manufacture fictitious indebtedness, and resort to other expedients of doubtful legality or morality in order to relieve the burden of taxation. Such methods are, of course, impossible where even ordinary ethics of honor and honesty prevail. Indeed, the methods of avoiding taxation heretofore outlined and such others along the same lines as the statutes of the various states may allow, are not free from criticism. They are legal, but are evasions of the spirit of the law. If, however, a legislature in its wisdom has decreed that a corpora- tion organized with both stocks and bonds shall have these latter deducted from the former in order to establish its taxable status, or that an obscure village where taxes are light may be selected by a wealthy city corporation as its principal office for taxation, there would seem no valid business reason why corpora- tions should not take advantage of the situation while it lasts and avoid all taxation that may be escaped without fraud and subornation of perjury. The same thing may also be said of incorporating in an outside state where taxation is less, and doing business at home as a foreign corporation. It is not a manifestation of the highest spirit of civic patriotism, but other- wise it is not to be condemned. Ch. 8] COST OF INCORPORATION 67 83. Counsel Fees The corporation is a creature of the law and in its forma- tion every requirement of the law must be observed. It is not sufficient that the corporation be merely brought into exist- ence. With the aid of a printed charter form, and a ready- made set of. by-laws, even the inexperienced may do this. It must be incorporated under the proper forms, with proper adjustment of detail, and with such knowledge of the condi- tions and possibilities that it secures every legitimate advantage allowed or permissible under the laws which authorize its crea- tion. For this reason lawyers, and the inevitable concomitant, lawyers' fees, are important features of any incorporation in which actual values are involved. Where cheap incorporations are imperative, or where the character of the incorporation does not justify the employment of an attorney, the incorporating agencies are usually employed at a cost of from $25 to $50, and the incorporation is secured in one of the cheaper incorporating states. Usually it is not worth more than it costs. For the better class of incorporations, where a really sound and effective organization is desired, the fees of any qualified attorney would hardly be less than $50, even where city prices do not prevail; and from this the fees would range far upward according to the complexity of the arrangements, the standing and experience of the counsel, and the increase of responsibility as property values increase. It is to be noted that an incorporation differs from the conduct of litigation in the fact that the amount of work and responsibility involved may be estimated in advance with reasonable accuracy. For this reason the proper counsel fees may be determined with precision and are usually agreed upon before incorporation is undertaken. In determining the fees the reputation of the counsel em- ployed frequently plays an important part. The known skill, experience, and standing which make up the reputation 68 CORPORATE LAW [Bk. I- of an eminent attorney not only insure the validity and the working value of the incorporation, but may, and frequently do, assist materially in the subsequent sale of corporate securities and in the general welfare of the corporation. It is obvious that if the incorporating counsel ranks high, his name in con- nection with the corporation is not only a guaranty of its technical correctness, but of the propriety of its purposes, the solidity of its undertaking, and generally of the status and character of the whole enterprise. 84. Corporate Equipment The cost of the stock books, certificates, seal, etc., necessary or usually employed in connection with a corporation, varies widely according to the nature of the outfit. The ordinary corporation of moderate capitalization and pretensions, desirous of restricting its expenditures, might secure everything necessary in neat and attractive shape for the modest sum of $10. This includes stock certificates, printed on lithographed blanks, the corporate seal, minute book, stock book, and transfer book. If a handsomer outfit is required, with special lithographed designs for certificates, and more costly bindings for books, the price of the outfit will easily run up to $40 or $50 and more. If specially engraved certificates are requisite or desired, this price will be increased to anywhere from $100 to $500, according to designs, character, etc. If bonds are to be included in any of these outfits, the cost will be doubled or trebled, according to the quality of the work and material. Loose-leaf minute books range in price from $3 to $15, according to style and size. The corporate books of account need be no different either in kind or cost from those used by an unincorporated concern. Part III The Stock System CHAPTER IX THE CAPITALIZATION 85. Capital It is necessary to discriminate between (i) capital, (2) capital stock, and (3) capitalization. 1. The "capital" of a corporation is the total amount of its assets of all kinds in excess of liabilities, up to the amount of the outstanding capital stock; assets over and above that amount constitute "surplus." 1 2. The "capital stock" of a corporation is the amount of stock it is authorized by its charter to issue. This is the usual significance of the term, though when used in the statutory law its meaning has been restricted to the amount actually paid in by the stockholders. 2 3. The "capitalization" of a corporation includes not only its shares of capital stock issued, but any bond issues or deben- tures that may be outstanding. These are termed generally "corporate securities." A late work on financing says: From a practical standpoint the authorized capital stock of a corporation is nothing more than a formal permission or authoriza- tion from the state to issue stock up to a specified amount. This amount, expressed in dollars or as a certain number of shares, 'Williams v. Western Union Tel. Co.. 93 N. Y. 162 (1883); Equitable Life Assurance Society v. Union Pacific R. R. Co.. 162 App. Div. (N. Y.) 81 (1914). J State v. Fire Association, 23 N. J. L. 195 (1851); Burrall v. Railroad Co., 75 N. Y. 211 (1878); People v. Morgan, 178 N. Y. 433 (1904). 69 yo CORPORATE LAW [Bk. I- when shares of no par value are employed is decided upon in the first place by the incorporators, is stated in their application for charter, and on allowance of the application becomes the authorized capital stock of the new corporation. It is supposed to be the amount of stock necessary or convenient for the purposes of the company. 3 Another writer defines the varying terms, as follows : By capital is meant in ordinary usage the actual property devoted to some productive end. It is the substance of the business. . . . . . . "capital" refers to the actual wealth employed in an undertaking, and "capitalization" to the representation of this wealth in terms of purely artificial and, in the end, fictitious values. A part of these representative values, namely those contributed by the proprietors, is designated "capital stock"; and the other part, that contributed by outsiders, is spoken of as "debt." . . . The term "capitalization" or the valuation of the capital, includes the capital stock and the debt. 4 86. Basis of Capitalization In the earlier history of business corporations, the capital stock of any particular company was usually determined by the amount of actual cash and property deemed necessary for the corporate purposes, or was restricted to an amount equal to the cash subscriptions which could be secured for the proposed exploitation. In either case the capitalization was intended to represent the actual cash or property values originally put into the corporate enterprise. At the present time the theory of capitalization has been somewhat modified and extended, and even in conservative operations, at least a portion of the earning value is usually included in the original capitalization. The modern theory is simple. Any enterprise may be con- sidered as worth the amount upon which, with due regard to 1 2 Financing an Enterprise, by H. R. Conyngton, p. 286. See Book II, Chs. XII, XIII, "Capitalization." 4 i Dewing on Finan. Policy of Corp., p. 4. Ch. 9] THE CAPITALIZATION 71 sinking fund and maintenance requirements, it can pay fair dividends, and it may therefore justly be capitalized at that figure. In other words, the earning capacity of the enterprise rather than the cash value of the property involved forms the usual basis of capitalization. As stated by a writer of eminence in financial matters: "The ultimate basis of all economic values, as will be observed frequently hereafter in this study, is the social service evidenced by earning power." 5 If fairly done and kept within reasonable bounds, this general basis of capitalization is hardly open to serious objection. On the contrary, in many cases there are substantial business reasons for its adoption. If the enterprise be capitalized on the basis of its immediate cash or cost value, it may, and should if meritorious, pay dividends far above the regular rates of interest or the usual returns on invested funds, and this fact inevitably attracts attention, provokes opposition, and invites competition. :'!'/>}' o- i> 87. Effect of Capitalization on Sale of Shares Also stock in a dividend-paying concern may usually be sold at a better price on a large capitalization, if this latter be justified by the dividend paid, than it possibly could on a more conservative valuation. For instance, if an enterprise were capitalized at, say, $200,000, on which it could earn and pay a regular annual dividend of 6%, its stock should sell readily at par, or 100. If its capitalization were reduced one-half, to $100,000, so that its regular annual dividend became 12%, the stock, having twice the earning power and representing the same corporate property, should theoretically sell at twice par, or 200. As a matter of fact it would do nothing of the kind, ordinarily bring- ing from 175 to 180 according to circumstances and showing the "cashing" value of the smaller capitalization to be from 10 to less than that of the larger. That is, the smaller ' i Dewing on Pinan. Policy of Corp., p. 43. 72 CORPORATE LAW [Bk. I- capitalization would involve a loss on the sale of the entire capital stock of from $20,000 to $25,000. As long as this is true, enter- prises will be capitalized on their earning capacity rather than on their actual immediate property value. This is treated more fully later in the chapter. Also, if capital is to be raised for a newly organized cor- poration, the larger capitalization, if within reasonable limits, gives much the better basis for the "bargain-counter" offerings so frequently necessary in the sale of stock. Greater induce- ments, at least in appearance, may be offered the buyer, and, as suggested in the preceding paragraph, from the standpoint of future transactions the position of the buyer himself is better. For these and other reasons the general practice at the present time, even in conservative circles, is to capitalize at that amount upon which the enterprise or undertaking may be reasonably expected to pay fair dividends that is, the earning capacity is made the basis of capitalization. The practice is often deprecated and may be easily carried so far under exaggerated estimates of earning as to become dangerous and at times dishonest. Kept within reasonable bounds, however, it would not seem to be objectionable from the standpoint of either morals or sound finance and it does give certain legitimate advantages. 88. Capitalization at Less Than Real Values In many cases the owners of small businesses in which but a few people are interested and to which others are not to be admitted, find it advantageous to incorporate at a capitali- zation much below the real value of the concern. Other con- ditions also arise in which the corporation with capitalization below its real value is a convenient business mechanism. The arrangement is advisable in all those cases where merely an apportionment of interest is desired under the corporate form. The fees and taxes are thereby kept at the minimum, the attention of competitors is not attracted, the organization itself Ch. 9] THE CAPITALIZATION 73 may be made very simple, and every purpose of the incorporation is effectively fulfilled. In those small and close corporations where profits threaten to become excessive as compared with the capitalization, the dividend rate is sometimes kept down by the distribution of surplus profits under the guise of salaries. It need hardly be said that the plan can only be adopted with justice and safety when all the stockholders participate in due proportion in these salary distributions. If fairly carried out the practice is legitimate. 6 89. Capitalization at Real Values In banks and other financial institutions the capital stock is fixed at the amount deemed necessary for the purposes of the business, and this capital stock is sold at par. In those states where a double liability attaches to the stock of financial institutions, the more solid of these require their subscribers to pay into surplus an amount equal to their subscriptions, or, in other words, the subscription price is placed at double the par value of the stock in order to cover this statutory liability in advance. In most mercantile businesses it is usual to approximate the real value of the enterprise- in the capitalization. Such valuation may, it is true, include good-will, trade-names, and the other more or less intangible assets of the business that differentiate the going concern from a mere stock of goods. In any established business it is obvious that these values are quite as actual as any of the more material properties and are quite as properly included in the capitalization. Their inclusion, however, does amount for all practical purposes to a capitalization on earning power. 90. Capitalization on Earning Capacity This is the rule in capitalizing corporate combinations and public utilities. Usually bonds or preferred stock, or See | 549- 74 CORPORATE LAW [Bk. I- both, are issued to the extent of the real values; then com- mon stock is issued to such amount as the estimated earning capacity will carry after payment of the dividends and interest on preferred stock and bonds. The overwhelming volume of watered stock that formerly emanated from public utility and industrial organizations and combinations was attributable to the excessively optimistic and misleading estimates of earning capacity made by promoters. If the earning capacity of these incorporations had been actually equal to the burdens imposed upon them, the large issues of stock would from some points of view have been fully justified, but in too many cases of this kind the dividends, where they came at all, were uncertain, irregular, or entirely inadequate. In determining the capitalization of speculative corporations organized to exploit mines, inventions, and other uncertain undertakings, an even more liberal spirit may prevail, the promoters estimating future earning powers on the basis of expectations. In some few cases such enterprises succeed, the capitalized anticipations are realized, and dividends are paid up to the promoter's brightest hopes. These few and exceptional instances then become an alleged justification for the over- capitalization of all similar undertakings. No safe rules can be formulated for the capitalization of these uncertain enterprises. Usually their stock must be sold at a tremendous discount from .face value. This calls for a propor- tionately large overcapitalization to which it is not usual to apply the ordinary principles of business. Caveat emptor let the buyer beware. 91. Capitalization of Good- Will The following definition of "good-will" is not the legal definition, but for our purpose it is possibly more useful : Money invested in bonds and other safely secured investments should, at the present high rates, bring annual returns of from 6 to 8 per cent. When invested in business it should bring con- Ch. 9] THE CAPITALIZA riON 75 siderably more to justify the greater risks involved, the percentage of annual returns then ranging from 10 per cent to 50 per cent or more, depending upon the character and conditions of the particular business. This difference between the returns on security investments and the returns on business operations may be designated as "good-will" returns, and good-will may be denned as the profit-producing power of an established business* beyond mere interest and replacement returns; or, from another point of view, as the value of an established business over and above the value of its material assets. 7 it) In the incorporation of any going concern or of any combina- tion or reorganization of going concerns, good-will is an asset of much importance and is as a matter of course included among the other assets to be capitalized. This practice is entirely legitimate, as the good- will stands for the difference between the real value of a live business and the property value of the stock, equipment, and other items which make up its implements of trade As a matter of fact, the good-will is not infrequently the most valuable asset of the concern, even where other assets are of considerable worth. On account of the intangible nature of good-will, its correct appraisement is often a matter of very considerable difficulty. Its value varies with local conditions and is at best almost entirely a matter of business judgment. Because of this diffi- culty of accurate valuation, good-will is a favorite device for inflating purposes and frequently affords a basis for unjustifi- able stock-watering. In the ordinary mercantile incorporation, good-will is often included without specific recognition. A lump sum is put upon the business as a whole and the corporation is capitalized at the figure so obtained. At other times a separation is effected between the property assets and good-will. Where this is done common stock is frequently issued to the appraised value of the good-will, while the cash and accounts, stock, machinery, realty, and other property assets are provided for by an issue of pre- 7 2 Financing an Enterprise, by H. R. Conyngton. p. 340. See Book II, Ch. XIII, "Capitalization Good- Will, Surplus and Initial Expense." 76 CORPORATE LAW [Bk. I- ferred stock, the two issues making up the total capitalization of the corporation. In this case the preferred stock represents the tangible assets, and its preference dividend is in the nature of a high interest on the actual value of this property. In the event of the dis- solution or liquidation of the corporation, this preferred stock is frequently paid out or redeemed before the common stock receives anything. 8 The common stock, on the other hand, representing the intangible assets the good-will and earning capacity of the business receives no dividend of any kind until all other obli- gations have been paid, and then only out of surplus profits. 92. Form of Capitalization After deciding upon the capitalization of an enterprise, a further question arises as to the form of this capitalization. The simplest plan is to have only common stock, but at times there are material advantages in the use of preferred stock. Preferred stock occupies a position between common stock and the bond. It is a safer form of investment than common stock, but it carries no rights of foreclosure. It takes prece- dence of common stock as to payment of dividends and fre- quently as to its ultimate redemption, but its dividend is not payable unless earned. Its dividend is fixed and it does not as a rule participate in excess profits, but its rate is usually much higher than the interest rate of a bond. Where preferred stock can be used to raise money, it is regarded as a much more satis- factory means than an issue of bonds. 93. Bond Issues Where a corporation has real property or invests in prop- erty having a tangible value, it is often of advantage to issue bonds in place of some portion of the stock capitalization. An enterprise requiring $150,000 in actual value might, instead of See Ch. XI. "Preferred Stock." Ch. 9] THE CAPITALIZATION 77 capitalizing for that amount, incorporate for but $100,000 and then issue bonds for the additional $50,000. The interest to be paid on these bonds would be less than the dividends a prosperous business would pay Upon the same amount of stock, and the difference represents a profit for the stock actually issued. Against this is the fact that the interest must be paid whether profits justify it or not, as also the further fact that if interest is not paid foreclosure proceedings will probably bring the corporation to an untimely termination or to a reorganization. In this latter case the proceedings are usually disastrous and most of the assets are likely to be ab- sorbed in settling the claims of the bondholders. Because of this the issuing of bonds is not safe unless the corporation is sound and of reasonably quick earning powers. If there is any doubt on these points, preferred stock, the security next to bonds in safety and desirability, is the more prudent method of raising money. 9 In arranging for a bond issue it is necessary to consider care- fully its possible effect on the local and federal taxation of the corporation. While the excess profits tax prevailed there was the objec- tion to a bond issue, that its amount could not be included with invested capital in computing exemption from the tax; hence preferred stock was usually issued instead. 94. Capitalization as Affected by Financial Exigencies If an enterprise is speculative in its character and the owners expect direct profits from its financing, or if promotion pay- ments are added to the load under which the new corporation is expected to stagger to success, the conditions do not tend to conservative capitalization. In such cases the immediate finan- cial necessities take precedence of almost everything else and the capitalization is shaped to that end. Profits for owners and promoters, bonus stock, commissions, advertising, and the gen- See Chs. LIV. LV, "Bonds"; see also i 78. 78 CORPORATE LAW [Bk. I- eral expenses of financing are included, until finally the actual business necessities of the corporation represent but a fraction of the total capitalization, and the final arrangement at times becomes a fraud upon the investing public. It is unfortunate that the capitalization of a corporation should be influenced by considerations such as these. At times, however, an enterprise will be of such a purely speculative nature that, with all honesty of purpose, it would be impossible to finance it on any conservative basis. Concessions to the necessities of the situation are then imperative, divergencies from the ideal corporate arrangements cannot be avoided, and the best that can be done is to reduce them to the minimum. In such cases the real interests of the corporation which are the successful inauguration and prosecution of its business and the production of profits for its stockholders should be kept closely in view and only such concessions made as are abso- lutely essential to successful financing, CHAPTER X STOCK 95. Capital Stock 1 The capital stock of a corporation is the maximum amount of stock it may issue under the provisions of its charter. This may bear some direct relation to the actual property values or "capital" possessed by the corporation from which it is to be absolutely distinguished or may be far above or below this real capital. The stock capitalization may be based : 1. On the actual cash value of the corporate property. 2. On the amount required for the development of the under- taking. 3. On the earning power of the corporate business. 4. On the speculative basis of what these earning powers may be when the business is developed. 5. On some combination of these factors. The capital stock of a corporation is fixed by its charter and can usually be increased or diminished only by amendment of that instrument. The capital stock of a corporation may be issued in part or in whole, and its total authorized amount bears no necessary relation to the amount of stock sold, subscribed, or outstand- ing. For instance, a corporation with a capital stock of $100,- ooo might have issued one-half of this amount, the remainder being reserved for subsequent use. The outstanding stock is then $50,000, but its capital stock is $100,000 and remains at 1 See also Book II, Ch. V, "Common Stock." and Ch. VI, "Preferred Stock." 79 80 CORPORATE LAW [Bk. I- this amount until changed by amendment of the charter or other statutory method. In this connection it should be noted that formerly, when the common law controlled, a corporation was required to have its entire capital stock subscribed before beginning busi- ness. Until this was done it could not enforce the subscrip- tions to its stock. 2 Now, however, in most states the strin- gency of this rule has by statutory enactments been greatly relaxed. Some minimum amount, fixed by statute and usually much smaller than the total stock capitalization, may be desig- nated by the charter as the amount with which the corporation will begin business, and as soon as this amount has been sub- scribed the corporation can enforce subscriptions to its stock and may begin its operations. In a few states a further pro- portion of the capital stock must be paid in within a specified tune, as in New York, where a corporation must have at least one-half its total capital stock paid up within one year from the date of incorporation. 3 96. Shares For the sake of accuracy and convenience in representing the interests of the various stockholders in the capitalization and in the corporate enterprise and property behind it, capital stock is divided into shares which are almost invariably of equal face value, and together make up the whole stock capi- talization. In the absence of statutory restriction there seems no reason why a corporation may not issue common and pre- ferred stock of different par values. In New York a provision in the corporate charter for such an arrangement would prob- ably be upheld. 4 In California, however, such a provision has been held invalid on the ground that it is in contravention of See i Cook on Corp., }J 176-181. * This law is largely a dead letter, as no one is charged with its enforcement and no penalty is imposed for failure to comply with its provisions. See White on Corp. (8th Ed.). P- 442. Ch. 10] STOCK 81 the statute declaring that no distinction shall be made between classes of stock as to voting power. & Unless restricted by statute, shares may be of any desired face value, though the greater portion of the issued stock of this country is in the form of $100 shares. Mining stocks are often issued in shares of the face value of $i, this being done with a view to more impressive offerings and to the reception of smaller subscriptions than could well be taken with larger shares. In any enterprise to be financed by popular subscrip- tion, a small share value is considered good policy, $10 being a figure frequently selected. Where the holders of stock are few in number and it is desired to render the sale or other dis- position of the stock difficult, or other reasons make such course advisable, the face value of the shares where not pro- hibited by statute is sometimes placed at $500 or more. The shares of the original Carnegie Company were $1,000 each, but the United States Steel Corporation placed its shares at $100 in order to facilitate their sale to the investing public. Unless there is some valid reason to the contrary, the generally recognized share value of $100 is to be preferred and selected. An interesting innovation in share values is the share of unspecified value, that is, a share without any named par value, such share merely representing a fractional interest in the profits and assets of the corporate enterprise. It is argued that such shares, lacking the "price ticket" of a nominal value, will force the investing public to investigate the real value of the enterprise and the real probability of profits, and thus determine the real value of the shares much more surely and quickly than under the present system of valued shares. 6 97. Certificates of Stock A certificate of stock is merely a convenient evidence of the ownership of corporate shares, and its loss or destruc- * Film Producers Inc. v. Jordan, 154 Pac. (Cal.) 605 (1916). * See Chs. XIV, XV, and XVI, discussing shares without par value. 82 CORPORATE LAW [Bk. I- tion does not affect such ownership in any way. The loss of the certificate may embarrass the stockholder on occasion, just as the loss of a deed to real estate or bill of sale to other prop- erty might be embarrassing, but he can still collect his divi- dends, attend and vote at stockholders' meetings, and generally perform his functions as a stockholder, just as he did before the loss of his certificate. If he wishes to sell or otherwise transfer his interest in the corporation, his certificate would probably have to be replaced before the purchaser or trans- feree would consent to take over the stock. Usually the cor- porate by-laws provide for the issue of a new cert ficate in case of loss or destruction of one already issued. The matter is, however, troublesome at the best, generally necessitating the giving of a bond or other guaranty to the corporation, and the loss of certificates is to be avoided if possible. 7 It is to be noted that the certificate of stock is purely a matter of form and convenience, that the ownership of stock may and frequently does exist before any certificates are issued, and that it would be entirely possible to conduct a cor- poration with the consent of its stockholders without the ssue of certificates at all, the stock books of the corporation Hhen being the sole evidence of stock ownership. While this is true, stockholders are entitled to certificates evidencing the stock owned by them and can force the issue of such certificates if withheld. At common law, certificates of stock are not negotiable, and if the owner of a certificate of stock loses it or it is stolen from him when indorsed in blank, a subsequent bona fide pur- chaser of such stock is not protected against the true owner, unless the owner was guilty of negligence. 8 By mercantile custom, however, stock certificates have been largely treated as negotiable instruments, and in a number of states certificates 'See }| 265, 359. 8 i Cook on Corp., { 358; Knox v. Eden Musee Co., 148 N. Y. 441 (1896). Ch. 10] STOCK 83 of stock have been made negotiable instruments under a statute generally known as the "Uniform Stock Transfer Act." 9 98. Unissued Capital Stock A corporation is empowered by its charter to issue stock up to the full amount of its authorized capital stock. At the time the charter is allowed all this stock is unissued. There- after it may be issued, in whole or in part, at the discretion of the corporation or as required by its operations. The unissued stock, no matter whether it be the whole capital stock or only a reserved portion thereof, represents nothing whatever beyond the potential right of issue. It has no intrinsic value. It is merely the right, granted by the state, to issue stock up to the prescribed amount. This being so, the unissued stock cannot in any way be regarded as an asset of the corporation. If sold it brings in cash, property, or other values that have a greater or less intrin- sic worth, but the outgoing stock carries with it an interest in the corporate property that should equal the value received for such stock. The general corporate property has been increased, but the ownership thereof has likewise been increased in the same proportion. In bookkeeping parlance the increase of assets and liabilities is exactly equal. The unissued stock therefore represents nothing more than the right to admit new members, or stockholders, into the corporation, upon payment of the proper quid pro quo. To regard it as an asset would be as illogical as to consider the right to admit new partners in a firm an asset of the partnership. 10 99. Issued Stock Stock is always supposed to be issued at its face or par value for cash or other actual values. At the time of organiza- These states are New York, Ohio, Pennsylvania, Rhode Island, Wisconsin, Louisiana, Maryland, Massachusetts, Michigan, New Jersey, Connecticut, Illinois, Tennessee, and also in Alaska. 10 See 5 123. 84 CORPORATE LAW [Bk. I- tion, therefore, the face value of the stock issued if full-paid would, theoretically, equal the actual value of the corporate assets. Even if this be true in fact, these values may, and generally do, vary widely thereafter. If the corporation is successful, its assets may increase far beyond the nominal value of its issued stock, while if unsuccessful these assets will probably fall far below the total face value of the issued stock. That is, the value of such stocks as shown by the books of the corporation will be far above or below the par value. The sell- ing price may, and, depending largely upon the rate of divi- dends maintained and the general desirability of the stock, probably will be at a still different figure. Frequently a corporation, by purchase, gift, or otherwise, regains its issued stock. Such stock coming back into the possession of the corporation is not retired thereby or brought back into the condition of unissued stock, but is designated as treasury stock, may be sold when desirable, and is usually regarded as an asset. 11 100. Full-Paid Stock In the absence of statutory laws to the contrary, stock may be issued on any basis that the directors, with the assent of the stockholders, deem best. That is, it may be issued for its full face value in money or property, or for only a portion of its face value, or on a promise to pay, or on partial pay- ments, or on no payment at all as a free gift. 12 If, however, it is not paid for at its full face value in money, property, or services where payment is allowed by services it is not full- paid stock, and therefore carries a liability to non-assenting stockholders and to creditors of the corporation for the amount still unpaid. 18 See Ch. XIII, "Treasury Stock." 12 2 Clark & Marshall on Corp., { 3903 and cases cited; I Cook on Corp., H 3O, 46; Scovill v. Thayer, 105 U. S. 143 (1881); In re Caledonia Coal Co., 254 Fed. Rep. 742 (1918). ' See Ch. XII, "Full-Paid Stock"; also 2 Clark & Marshall on Corp., H 397, 401; Camden v. Smart, 144 U.S. 104 (1892); Merchants', etc.. Agency v. Davidson, 23 Cal. App. 274 (1913). Ch. 10] STOCK 85 The courts have shown a tendency of late years to con- strue the law more strictly against any dubious, unfair, or in- equitable payment of stock when the rights of creditors or stockholders are concerned. 14 The term "watered stock" is merely a convenient desig- nation for stock issued in excess of the values behind it. 15 101. Common and Preferred Stock 16 Preferred stock is that to which some preference has been given over other stock of the same corporation as to partici- pation in profits, and often in assets in case of liquidation. If there is no distinction in regard to these two features the stock of a corporation is all common stock. Different preferred stocks may be issued by the same cor- poration in any desired variety of preference as to dividends and redemption or liquidation rights. These are distinguished from each other as first, second, and third preferred stock, or by other designations descriptive of the peculiar status of each stock. 102. Other Classifications As stated, the capital stock of a corporation may be divided into common and preferred stock on the basis of its relation to the corporate profits or property. Stock may also be classified in other ways. Most of these other classifications relate to the voting right. The simplest is a division of the stock into two classes, one class voting, the other not exercising this right. (This classification, however, would not be permitted under the California statute.) For instance, in the incorporation of a partnership where one or more take the active management, >* See v. Heppenheimer, 69 N. J. Eq. 36 (1905); Arnold v. Searing, 73 N. J. Eq. 262 (1907); s. c. 78 Atl. Rep. 762 (1910); Mason v. Carrothers, 105 Me. 392 (1909); Old Dominion Copper Co. v. Bigelow, 188 Mass. 315 (1905); s. c., 203 Mass. 159 (1909); Bigelow v. Old Dominion Copper Co., 74 N. J. Eq. 457 (1908); same facts in Old Dominion Copper Co. v. Lewisohn, 210 U. S. 206 (1008). " See 55 119, 120. "See Ch. XI, "Preferred Stock"; also Book II, Ch. V, "Common Stock," and Ch. VI. "Preferred Stock." 86 CORPORATE LAW [Bk. I- others merely supplying the capital, the active partners might have their interests represented by voting stock and the interest of the silent partners represented by non- voting stock. 1 1 Other classifications are possible in considerable variety, and generally it may be said that any desired classification is allowable that is not repugnant to equity, to the common law, or to the statute law of the state under which the corporation is organized. On the other hand, it may be said that unusual classifications, unless clearly demanded by the conditions, are not to be recommended. They may work unexpected hard- ships, are at times very uncertain in their actions, and introduce undesirable complexities into the corporate mechanism. Classifications of stock may be authorized either by charter or by-law provisions. As a matter of prudence they should be incorporated in the charter where possible. The specifica- tions relating to any class of stock, except unmodified common stock, should be printed in full on the face of each certificate by which such stock is represented. 18 "See Ch. LIX, "Incorporating a Partnership." is See 481, 534. CHAPTER XI PREFERRED STOCK 1 103. Nature and Use Preferred stock is that which has some preference as to dividends or assets over other stock of the same corporation. This preference is usually given to make such stock safer or more attractive, though at times its purpose is to limit divi- dends or gain some other desired end. Preferred stock is perhaps most commonly employed where money is to be raised for the development or operation of a corporate enterprise. For this purpose it may be made to offer greater safety both as to principal and dividends than common stock, while it does not carry the dangerous foreclosure privi- lege of the bond. When a business is incorporated, preferred stock is fre- quently issued to represent or pay for the actual property assets; the good- will and other intangible assets being repre- sented by an issue of common stock. When a partnership is incorporated, the excess investment of one partner is very often represented or satisfied by an issue of non-voting preferred stock, while the interests of a silent partner may be conven- iently cared for by the same means. Where an invention or other property is taken over and payment made in stock, the transferrer, on account of its greater safety, will frequently demand a portion or the whole of his price in preferred stock, and generally the device will be found most useful in effecting the adjustments and allowances so frequently necessary in incorporating. See Book II, Ch. VI, "Preferred Stock." 87 88 CORPORATE LAW [Bk. I- Usually preferred stock is created by charter provision, the preferences and restrictions being set forth at length. In many states it may be authorized by proper by-law provisions, but it is always better and safer to provide for it in the charter. 2 After incorporation, unless otherwise provided by statute, the assent of every stockholder is required for the issue of pre- ferred stock. This is reasonable, as the value of the common stock may be depreciated by such an issue. In many states the statutes allow preferred stock to be issued after incorporation when authorized by a prescribed majority of the outstanding stock. 3 104. Certificates for Preferred Stock Preferred stock is issued in many different forms and with many different classifications, privileges, and restrictions. The possible range is wide and includes almost any desired attribute not contrary to law or public policy. All the conditions of any particular issue should appear upon the face of the certificate by which such preferred stock is represented. If the specifica- tions are too voluminous for this, the fact that the certificate represents preferred stock should appear plainly on its face, together with a reference to the provisions of the charter by which such stock is authorized. Such notice is sufficient to put any intending purchaser on his guard, and if he purchases the stock he cannot afterward assert ignorance of its conditions as a basis for litigation or claims against the corporation, 105. Rights Carried by Preferred Stock Unless specifically prohibited therefrom by proper provision in the charter, by-laws, or other authorization under which such stock is issued, preferred stock carries the right to vote and the right to participate in dividends beyond the preferential divi- dend after the common stock has received a dividend equal * i Cook on Corp., r J 268; Toledo, etc., R. R. v. Trust Co., 95 Fed. 497 (1899); Kent v. Quicksilver Mining Co., 78 N. Y. 159 (1879). 3 Hinckley v. S. & S. Co.. 107 App. Div. (N. Y.) 470 (1905); s. c., 193 N. Y. S99 (1908). Ch. 11] PREFERRED STOCK 89 thereto. That is, in any year, if the preferred dividend is paid and the common stock has received a dividend equal in amount to this preferential dividend, then any further dividends belong to and must be paid to all the stock, common and preferred alike. 4 Preferred stock is also entitled to cumulative dividends unless otherwise provided. Preferred stock has no preference over common stock in the distribution of assets in case of liqui- dation or dissolution, unless such preference is specifically given by statute or set forth in the authorizing provisions. 1 06. Preferred Stock Compared with Bonds Preferred stock differs from a bond issue in the very material feature that interest on bonds must be paid when due and can be enforced by a foreclosure suit, while dividends on preferred stock are payable only from net profits and, if profits are not made, are not due and therefore cannot be collected. Also bonds must be paid on. maturity, while preferred stock has no fixed due date. Bondholders are creditors of the company. The holders of preferred stock are not creditors of the company, have no claim against the company except for dividends when declared, and have no rights, save for their preferences, superior to those of the common stockholders. 5 For these reasons the issue of preferred stock is much safer for the ordinary corpora- tion than the issue of bonds. Preferred stock is much favored in the formation of industrial trusts. Sometimes an attempt is made, in order to interest investors, to issue special forms of securities which shall have for the investor the advantages both of preferred stock and of bonds. So far all such attempts have been unsuccessful. The courts will not permit the same security to create the two inconsistent relationships of stockholder and secured creditor. Irrespective of what the security may be called, they will look behind the See | ill. i Cook on Corp., 5 271; Warren v. King, 108 U. S. 380 (1883); St. John v. Erie Ry. Co. 22 Wall. 136 (1874); Field v. Manufacturing Co., 162 Mass. 388 (1894); Ellsworth v. Lyons. 181 Fed. ss (1910). QO CORPORATE LAW [Bk. I- name, determine the essential character of the security, whether it is that of a bond or of stock, and limit the holder to such rights as lawfully belong to that class of security. In many states there are statutory provisions relating to preferred stock which must be consulted when the subject is under consideration, these statute laws taking precedence of the general or common law herein set forth. This, for instance, is the case in New Jersey, where among other requirements it is provided that "at no time shall the total amount of the pre- ferred stocks issued and outstanding exceed two-thirds of the capital stock paid for in cash or property." Statutory authorization for the issue of -preferred stock is not necessary. 7 The provisions creating preferred stock should be framed with care, for the law reports abound with suits aris- ing from ill-defined preference stock rights. 8 107. Preference as to Dividends The following extract gives a common form of charter pro- vision authorizing the issue of a simple preferred stock: Of said capital stock, five hundred shares of the par value of fifty thousand dollars shall be preferred stock, entitled to receive from the net earnings of the company an annual dividend of 6 per cent before any dividends are paid upon the common stock. The holder of a preferred stock, such as provided in the paragraph quoted, would have the same voting right as the holder of common stock; his dividends, although this is not specifically stated in the creating clause, would be cumulative, and he would participate in any general dividends in excess of the preferential dividend already received. In case of liquida- tion of the corporation he would in most states have no claim 1 i Cook on Corp., 271. 7 Kent v. Quicksilver Mining Co., 78 N. Y. 159 (1879); Roberts v. Robert- Wicks Co., 184 N. Y. 257 (1906); Equitable Life Assurance Society v. Union Pacific R. R. Co., 162 App. Div. (N. Y.) 81 (1914); Sterling v. Watson Co., 241 Pa. St. 105 (1913); In re Fechheimer Fishei Co., 212 Fed. 357 (1914). 8 1 Machen on Corp., 5 549. Ch. n] PREFERRED STOCK gi to preference on the distribution of assets, but would come in on the same basis as the holder of common stock. Preference as to dividends may be as to time and amount, as in the creating clause given, or may be as to profits from certain sources, as where a preferred stock is to receive all the profits of a certain plant or a particular branch of the business. The usual rate of dividend on preferred stock ranges from 6 to 8%, though but few reliable stocks bear this latter rate. In some states the rate is limited by statute to a maximum of 8 %- Wi "T^ 1 08. Preference as to Assets Unless otherwise specifically provided, preferred stock par- ticipates in any distribution of assets upon the liquidation of the corporate property just as common stock does, but has no preference. 9 Some preference in this respect is usual, the cus- tomary arrangement requiring the payment of the par value of preferred stock with all arrearages of dividends before anything is paid upon the common stock. In some states preferred stock carries this right under the statute law unless otherwise specifi- cally provided by the creating provisions, but even in such states it would be better to incorporate this preference in the charter to prevent any mistake or misapprehension as to the status of the stock. 10 109. Cumulative Dividends Preferred stock bearing cumulative dividends is sometimes called "guaranteed stock" but the term is not well applied, being used with greater propriety to describe stock upon which the dividends are guaranteed by some other corporation. This latter form of stock is a not uncommon expedient in arranging the terms of railroad combinations, and the employment of the * i Morawetz on Corp., } 461; I Cook on Corp., 5 278. 10 i Machen on Corp., $ 551; Boardman v. Lake Shore, etc., R. R., 84 N. Y. 157 (1881); Elkins v. Camden, etc., Ry. Co., 36 N. J. Eq. 233 (1882). 92 CORPORATE LAW [Bk. I- term "guaranteed stock" in that connection is the more common as well as the better use. Preferred stock may be cumulative or non-cumulative. If the former, its dividends are not payable if not earned, but when profits are earned its unpaid dividends, past or present, are a first charge against such profits and must be paid before the common stock receives anything. If preferred stock is non- cumulative, a passed dividend is lost and is not a charge against the company in any way. Usually a non-cumulative preferred stock is not a desirable holding. Its existence is a standing inducement to the improper passing of dividends. The courts sometimes interfere on behalf of the holders of non-cumulative stock where profits have been made and the directors unjustly refuse to pay dividends. 110. Non-Cumulative Preferred Stock Non-cumulative preferred stock is, as stated, undesirable. It is, in fact, a standing invitation to the directors, unless their ethical standards are high, to administer the corporate finances to the advantage of the common stockholder. Profits that might very properly have been applied to the preferred divi- dends are diverted into improvements or developments. These redound to the ultimate advantage of the company, but mean- while stand in the way of the dividends on the non-cumulative preferred stock until the company has reached a point where common and preferred stock dividends are both possible and can be paid together. The preferred stockholder's dividends for this deferred period are absolutely lost so far as he is con- cerned. The company has profited at his expense. The direc- tors might properly have paid them if they would, but decided in favor of the common stockholder. If investors were wise there would be no sale for non- cumulative stock, for there is no legal way for the holder of such stock to prevent the directors postponing dividends until Ch. n] PREFERRED STOCK 93 the common stockholders can share equally or even receive more than do the holders of preferred stock. 11 It is to be noted that if the preferential dividend is to be non-cumulative, this fact must be clearly expressed in the char- ter provisions by which the stock is authorized. Where not so expressed, the courts have held the preferential dividends to be cumulative and payable in full out of the first profits before anything is received by the common stock. The cumulative feature of preferred stock is, however, for the sake of security and definiteness usually covered by express provision. in. Participation in General Dividends As already stated, unless otherwise expressly provided, pre- ferred stock participates equally with the common stock in all dividends after both common and preferred have received an equal dividend. That is, if the preferred stock has received its preferential dividend of, say, 6% together with any cumu- lated arrearages, it participates no further in dividends until 6% has been paid upon the common stock as well, but thereafter both classes of stock stand upon exactly the same basis as to any further dividends declared during that year. If such further participation on the part of the preferred stock is not desired, it must be expressly denied. Such participation privilege beyond the preferential divi- dend is not common. It is sometimes employed to advantage in the adjustment of interests among incorporating parties, but is usually found only where the stock must be made attractive above the common, as in a speculative corporation where the risks are extra-hazardous, or under other conditions necessi- tating unusual inducements to investors. ' 112. Comparison of Participating and Bonus Stock Sometimes when preferred stock is to be made attractive beyond the ordinary, it is limited to its preferential dividend, " But see Book II, H 61,62. 94 CORPORATE LAW [Bk. I- but a common stock bonus of equal amount is given with it. This plan is, however, much less advantageous for the other stockholders than the use of participating preferred stock, as it involves (i) the payment of additional dividends on stock equal in amount to the preferred stock, (2) an additional voting right in the management, (3) in event of liquidation a double claim against the assets. Further, the receipt of bonus stock may involve the holder in a liability to creditors. 12 To avoid misunderstanding when a participating preferred stock is issued, a distinct provision in the authorizing charter or by-law clause should cover such participation. 113. Redemption Right Preferred stock is often issued with the proviso that after a certain period and after specified notice, the corporation shall have the right to buy in or redeem its outstanding preferred stock at some previously designated price. Provisions in regard to the redemptions of preferred stock are found in the laws of a number of states, for the most part referring to the time and rate of redemption. In the absence of any prohibition, the redemption of preferred stock under suitable conditions would seem to be entirely within, the power of the corporation, though a provision of this kind would not be permissible in a state where corporations are forbidden to acquire their own stock. 13 "The relation of classes of stockhold- ers to each other and to the corporation is, unless governed by statute, purely contractual." 14 It is also to be noted that under no circumstances would the corporation have the right to redeem preferred stock when by so doing it would impair its capital stock or affect the rights of " Holcombe v. Trenton White City Co., 82 Atl. (N. J.) 618 (1912). 13 Hackett v. North Pac. Ry. Co., 36 Misc. (N. Y.) 583 (1901). In this case a foreign corporation was authorized to issue preferred stock by a vote of a majority of stockholders. A condition that the corporation might on the first day of January in any year prior to 1917 retire such preferred stock at par, was held valid. 14 Equitable Life Assurance Society v. Union Pacific R. R. Co., 162 App. Div. (N. Y.) 81 (1914)- Ch. n] PREFERRED STOCK 95 creditors. 15 For this reason such redemption should be made permissive, not mandatory, as, if made mandatory, the cor- poration might later find itself under contract obligation to do an illegal act. The redemption right is sometimes of considerable import- ance, and should be retained if it can be done without injury to the sale of the preferred stock. Dividend rates on preferred stock are usually higher than interest rates on borrowed money, and, if the corporation accumulates surplus profits, the pre- ferred stock may be redeemed and its high preferred dividends terminated with much advantage. If the redemption period is reasonably remote, say five years or more, and the redemption price is attractive, this right may be provided without detri- ment to the salability of the stock affected. The redemption price of preferred stock varies with the conditions. Always, as a prerequisite, the payment of any accrued dividends is involved. Frequently the price is fixed at the par value of the stock plus one year's dividend. At other times it is arbitrarily placed at a figure thought attractive or fair, as 105, no, or even more under some circumstances. Occasionally the holders of the preferred stock will be given the option of exchanging their stock for common stock instead of taking the redemption price. Preferred stock when redeemed is no longer a claim against the dividends or assets of the company. It is, however, still a part of the capitalization of the company, and might, with the assent of the stockholders, be reissued. 114. Voting Rights Unless otherwise expressly provided, preferred stockholders have exactly the same right to participate in corporate meet- ings and to vote upon their stock as do the holders of common stocks 6 Usually, however, this voting right and the right to Ellsworth v. Lyons, 181 Fed. 55 (1910). > i Machen on Corp., { 570. 96 CORPORATE LAW [Bk. I- participate in stockholders' meetings is denied the preferred stock, the power of management being reserved to the common stock. In such case the provisions by which the preferred stock is created should state clearly the fact of its non-voting char- acter, and this fact should also appear plainly upon the face of the certificate by which such preferred stock is represented. Under such circumstances the preferred stockholders have no more voice in the management of the corporation than have its bondholders. Unless prohibited in some way, it is entirely within the power of the corporation to deny the voting power to preferred stock before issuance. "There is no rule of public policy which forbids a corporation and its stockholders from making any contract they please in regard to restrictions on the voting power. If the agreement is made by unanimous consent it is legal." 17 In California, how- ever, the statutes provide that no preference as to voting power may be granted to any class of stock. 18 A variation of the plan of absolute non-representation is to provide that the holders of preferred stock shall not vote so long as the preferential dividends are paid with reasonable regularity, but that if such preferential dividends fail, say for two consecutive years, then the holders of preferred stock shall thereafter have the right to vote. This plan has the appearance of equity. If those in charge of the corporation cannot manage the corporate business so as to pay dividends on even the preferred stock, it would seem but reasonable that the holders of preferred stock, who suffer by this mismanagement, should be allowed a voice in its con- trol. If interest is not paid on a bond issue, foreclosure results and the bondholders not infrequently buy in and conduct the 17 2 Cook on Corp., 5 622b, cited in State v. Swanger, 190 Mo. 561 (1905); People ex ret Brown v. Koenig, 133 A. D. (N. Y.) 756 (1909); Equitable Life Assurance Society v. Union Pacific R. R. Co., 162 App. Div. (N. Y.) 81 (1914)- 18 Film Producers Inc. v. Jordan, 154 Pac. (Cal.) 605 (1916). Ch. n] PREFERRED STOCK 97 business. Giving the preferred stock a conditional voice in the management is a far milder application of the same principle. 115. Convertible Stock Dr. Dewing says: Preferred shares, when convertible, are almost invariably con- vertible into common shares. The conversion privilege in such cases is usually attached to the preferred stock for the purpose of attracting the elusive "speculative investor," as the genus is called, who wants security and regularity of income at the same time that he holds the opportunity of participating in any extra- ordinary profits to be realized in the future. Clearly such convertible preferred shares are of commonest occurrence in the manufacturing field, where the lure of sudden and marvelous profits holds more promise than in the prosaic fields of the railroad and public service industries. 19 In New Jersey, by statutory enactment corporations answer- ing to certain descriptive conditions were allowed to redeem their preferred stock the holders consenting with bonds. By a singular coincidence, the United States Steel Corporation was found to be within the descriptive prescriptions, and, with the consent of two-thirds of its outstanding voting stock, it offered the holders of its 7% preferred stock the privilege of exchanging such stock for 5% bonds. The exchange was entirely optional with the holders of the preferred stock, but the measure aroused bitter opposition and litigation. The exchange was finally upheld. 20 In the absence of permitting statutory provisions, any such exchange or arrangement for such exchange would be illegal. 116. Founders' Shares In England, founders' shares, a kind of preferred stock which may be described as a privileged deferred stock, are frequently issued. 21 H I Dewing on Finan. Policy of Corp., p. 140. 20 Berger v. U. S. Steel Corp., 63 N. J. Eq. 506; s. c., 809 (1902). "See Book II, j 54, 55. g8 CORPORATE LAW [Bk. I- \ ' To illustrate, a corporation capitalized at $300,000 with $100,000 of this as preferred stock and $200,000 as common stock, might have $25,000 of this common stock set aside as founders' shares with specified dividend rights equal perhaps to all the other common stock. That is, under the supposed arrangement, after the preferred stock had received its dividend, any further dividends would be divided into two equal parts, one of which would go to the ordinary common stock, the other to the founders' shares. Under this arrangement the $25,000 of founders' shares would equal $175,000 of the ordinary shares so far as participation in dividends was concerned. Under such conditions the founders' shares might have a value many times in excess of that of the common stock. Where employed, such shares are usually reserved as an emolument for the promoters of the enterprise, or as compensation to men of eminence or financial repute for the use of their names. 117. Founders' Shares in This Country It is supposed that under the New Jersey laws, and under the laws of some other states, these founders' shares might be legally issued. Some few companies have been organized upon this basis, but it does not appear that the subject has ever come up for adjudication in this country, and it is not certain what view might be taken of the matter by the courts. Probably, if accomplished by proper charter provisions and with the full knowledge of the stockholders generally and with all due pub- licity, the arrangement would stand. As everything to be secured by the use of the founders' shares can, however, be accomplished by the skillful but recognized and adjudicated use of common and preferred stock, it would hardly seem wise to venture on ground that is ; at the best, experimental and of doubtful utility. CHAPTER XII * FULL-PAID STOCK 1 1 8. General A subscriber to stock on its original issue, when his subscrip- tion is accepted, becomes a stockholder. He may pay for his stock at once, or in instalments, or as assessments are laid by the directors. Until its par value is paid, each subscriber is liable for the amount unpaid. The subscriber must' pay its par or nominal value under penalty of possible liability to the corpora- tion or its creditors for the amount necessary to make up the full face value of any stock partly or wholly unpaid In most states full-paid stock carries no liability, either in favor of the issuing corporation or of the creditors of that corpor- ation. 1 119. Watered Stock Watered stock is stock issued without adequate supporting values therefor having come into the possession of the corpora- tion. Many states explicitly prohibit its issuance by statute. Where not prohibited, watered stock may be created : 1. By the issue of "full-paid" stock for cash at less than its par value. 2. By its issuance as a stock dividend without sufficient increase of the corporate property to support the issue. 3. By its issuance as a bonus with preferred stock or bonds. 4. As is the method in the great majority of cases, by its issuance for property or services at an overvaluation. The most obvious form of watered stock is the stock dividend occasionally issued by the large public utility corporations where 1 See i 121. 99 100 CORPORATE LAW [Bk. I- there is no pretense of any increased value in the property behind the stock, the issue being justified only by an earning capacity sufficient to pay dividends upon the increased capitalization. If the corporation were forced into liquidation, the stock would receive only a fraction of its face value. Such a stock dividend must be distinguished from a stock dividend paid in lieu of cash dividends of equal amount, where the reserved cash or equivalent property is added to the working capital of the company. In such case the issued stock represents actually increased values, capable of realization in event of the liquidation of the company. The most common form of watered stock is stock issued in the purchase of property at an overvaluation. Such stock is nominally full-paid, and in some cases by the subsequent pros- perity of the corporation the anticipations of its promoters are realized and the stock is removed from the category of watered stock. In the majority of cases, however, the corporation does not meet the expectations of its organizers, and the issued stock is left with but little support. In such case, if the undertaking is of sufficient value in actual property or in possible profits to justify the step, a reorganization takes place, the capital stock is greatly reduced, thereby "squeezing" the water out of it, and the corporation is placed on a decreased, but usually much sounder, basis. 2 120. Legal Status of Watered Stock Stock issued for less than its full face value without agree- ment between the parties thereto as to the nature of such stock, is partly paid stock, and the purchaser is liable to the corporation, or in event of the insolvency of the corporation to its credi- tors, for the amount necessary to make up the full face value of such stock. If, however, it is agreed between the purchaser and the corporation that the price paid shall be in full settlement of the claims of the corporation against such stock, then as between 'See 5 125. Ch. 12] FULL-PAID STOCK IOI these parties the stock is full-paid, and in the absence of fraud the holder is under no liability to the corporation. 8 This is true as to the corporation but not as to its subsequent creditors unless by agreement of these latter. In event of the insolvency of the corporation, these creditors might proceed against the original purchasers of any watered or partly paid stock so long as such stock remained in their hands, and collect from them the amount necessary to render -their stock full-paid. 4 This possible liability follows the unpaid stock into the hands of transferees purchasing such stock with a knowledge of its character, but does not follow it into the hands of an innocent purchaser for value. 5 It is to be noted that the general doctrine as stated requires modification in those cases where the board of directors of a cor- poration has issued stock for property or services, in good faith and without fraud, and later developments prove the considera- tion to have been or to be worth less than the face value of the stock. 6 In most states of the Union, if it can be shown that the directors exercised proper care in the investigation and acceptance of the property, the courts refuse to hold the recipi- ents of the stock liable on the ground of failure or insufficiency of the consideration. 7 121. Legal Status of Full-Paid Stock Full-paid stock carries no liability of any kind, either to the corporation or its creditors, save in those few states where by statute special liabilities have been created. This freedom from liability, no matter what the vicissitudes of the corporation, gives to stock its desirability as a form of investment. As this feature pertains only to full-paid stock, it is a great object in the organi- zation of a new corporation to render its stock full-paid. . * I Cook on Corp., } 30, 46; Scovill v. Thayer, 105 U. S. 143 (1881); Christensen v. Eno, 106 N. Y. 97 (1887); Southworth v. Morgan, 205 N. Y. 293 (1912). 4 Cohen v. Toy Gun Mfg. Co., 172 111. App. 330 (1912); Gilson v. Appleby, 82 N. J. L. 400 (1911). * See i 122. Douglass v. Ireland, 73 N. Y. 100 (1878); Hayes v. Iron Co., 165 Pa. St. 489 (1893). 7 Holcombe v. Trenton White City Co., 82 Atl. (N. J.) 618 (1912); Whitlock v. Alexander, 160 N. C. 465 (1912). 102 CORPORATE LAW [Bk. I- Where stock is issued at par for cash, which with financial institutions is usually a matter of statutory obligation, or for cash and substantial property equaling the actual face value of the stock as in the case of solid business corporations, the ques- tion does not arise. The ordinary corporation, however, cannot as a rule sell its stock at par, particularly when it is organized for the development of some new or speculative enterprise. To issue such stock direct for less than par would leave the pur- chasers if purchasers could be found liable for the difference. Various expedients are therefore utilized to render this stock full- paid before it is sold to the actual purchasers for cash, and the methods adopted to secure this end have given rise to most, if not all, of the litigation relating to the full payment of stock, s 122. Certificates for Full-Paid Stock When stock is full-paid the securities by which it is repre- sented usually bear upon their face the words "full-paid and non-assessable." There is no legal requirement that the cer- tificates shall be so inscribed, but if they were not the purchasers would and very properly be suspicious of the stock. The direct and legitimate inference from the omission would be that such stock was not full-paid and non-assessable and might carry latent liabilities. If stock is not full-paid, the label will not shield stockholders who know the facts. On the other hand, where certificates are marked "full-paid and non-assessable," such stock may be bought in the open market from a lawful holder with full confidence that its purchase involves no unknown liabilities. Even should it later prove to have been but partly paid, or not paid at all, the innocent pur- chaser for value could not be held liable on that account. He purchased on the faith of the unquestioned statement on the stock certificate that such stock was full-paid, and so far as he is concerned the stock will be held to bear that character. 9 If, 8 See Ch. XIII, "Treasury Stock." i Cook on Corp., } 50, 257, note 4; Sprague v. National Bank of Amer., 172 111. 149 (1898); French v. Harding, 83 Atl. (Pa.) 586 (1912). Ch. 12] FULL-PAID STOCK 103 however, the purchaser knew that the stock had not been hon- estly full-paid, he would, as already stated, take with notice and might be held liable for any deficiency. 10 Where the statute requires a certificate of full payment to be filed in a public office, the fact that such certificate has not been filed has been held to be sufficient to give a purchaser notice that the stock was not fully paid. 11 The impressive word "non-assessable" merely indicates that the corporation has either received full payment of the stock in question, or otherwise that it has relinquished any claim it might have on such stock for further payments or assessments of any kind. Full-paid stock is non-assessable under any circumstances except in California and a limited number of other states where the statutes permit the corporation to levy assessments. In some few states certificates representing stock issued for property must bear the legend "issued for property" or some equivalent statement. Elsewhere this is neither necessary nor desirable. Such stock is of no different nature or legal status from any other stock, and to inscribe it in the manner indicated conveys the impression that some difference actually exists. 10 See { 120; also i Cook on Corp., 49; 2 Clark & Marshall on Corp., 4Oik; Wallace v. Carpenter, etc., Co., 70 Minn. 321 (1897); Coleman v. Howe, 154 111. 458 (1895); Gillett v. Chicago Title & Trust Co., 230 111. 373 (1907). " White, Corbin & Co. v. Jones. 167 N. Y. 158 (1901). CHAPTER XIII TREASURY STOCK 123. Unissued Stock The term "treasury stock" is employed very loosely by busi- ness men and accountants to describe unissued stock. It would be better to use the term to designate the issued and outstanding stock of the company that has been donated to or purchased by the corporation and which is held subject to disposal by the directors. Such stock is properly treasury stock, is the property of the company, and, technically at least, is an asset on the books of the company. 1 To style unissued stock "treasury stock" is obviously a mis- nomer. Unissued stock is merely the privilege of creating a liability. It is not in any sense of the word an asset. For $20 the state of Arizona will charter a corporation and authorize it to issue stock to the face value of $25,000,000 or more. Such a company on organization would have an overplentiful supply of unissued stock, but no assets whatever. The absurdity of re- garding its unissued stock as an asset is obvious. 124. Issued Stock Stock that has been once legally issued for full, honest value, however, is of a very different nature. It is then full-paid stock and represents a certain interest in the corporate property. If any of it comes back into the possession of the company it is still "full-paid stock" and is then with some logical correctness con- sidered an asset. Such stock is properly classified as treasury stock and may be sold below par to raise funds for the operations ' See { 98; also Book III, Ch. IX, "Treasury Stock with a Par Value"; see also Mont- gomery on Auditing, p. 206. 104 Ch. 13] TREASURY STOCK 105 of the company, may be given away as a bonus with preferred stock or bonds, or be otherwise used without involving the recip- ient in any liability to creditors of the corporation. 2 In case such treasury stock were originally issued for property at an overvaluation, an innocent purchaser for value cannot be held liable, but a purchaser with knowledge of the overvaluation might be. 3 125. Origin of Treasury Stock If a corporation were organized upon a strictly cash basis, each subscriber paying the par value for his stock, it would have no treasury stock at the time of organization. Later, should a portion of this issued stock come back into the possession of the company in settlement of some debt or through other negotia- tion, such returned stock would be treasury stock and from the bookkeeping standpoint an asset of the company. Unless expressly prohibited by statute, a corporation may purchase its own issued stock. Such a purchase can be made only with surplus or profits, and must under no circumstances impair the capital stock of the company; also it must be made in good faith and with due regard to the rights of other stock- holders and of creditors. Such a purchase may be made to retire an officer. 4 Stock so purchased would be treasury stock and an asset of the company. When, however, as is so frequently the case, a corporation is organized under the usual plan to exploit some mine, invention, or other enterprise, or to make a combination of existing corpor- ations, it issues all or a large portion of its stock in payment for the property assigned to the corporation. This stock is thereby rendered nominally full-paid. Then by agreement, or by under- standing, the recipient of this stock assigns back to the corpora- 1 1 Cook on Corp., } ( 46-50; I Morawetz on Corp.. } 306; 2 Clark & Marshall on Corp., i 39Oe; Lake Superior Iron Co. v. Drexel, 90 N. Y. 87 (1882); Insurance Press v. Montauk, etc., Co., 103 A. D. (N. Y.) 472 (1905). 'Ailing v. Wenzel, 133 111. 264 (1890); Coleman v. Howe, 154 111. 458 (1895); Berry v. Rood, 168 Mo. 316 (1901). 'Joseph v. Raff, 82 App. Div. (N. Y.) 4? (1903); Vail v. Hamilton, 85 N. Y. 453 (1881). io6 CORPORATE LAW [Bk. I- tion, or to some trustee for the corporation, a proportion of this full-paid stock to be used for company purposes. This is treas- ury stock of the company and in the present day it is thus, as a general rule, that treasury stock is obtained. Such stock is usually a clear donation, the disposition to be made of the stock being sometimes prescribed, but generally left to the discretion of the board of directors. Such procedure is not always disap- proved by the courts. The individual defendants then transferred back to the company a certain amount of stock which was to become the property of the company, and to be disposed of by it for its own benefit. Such a condition is not unusual in companies of this character. In order to make its stock of any value, it was essential that the company should have a working capital in addition to the patents, and the persons who had exchanged their patents for the stock of the company were wi ling to give to the company a portion of their stock so that the working capital could be secured and thus give value to the remainder of the stock. 5 126. The Present Attitude of the Courts It is to be noted, however, that in harmony with the present general trend towards stricter regulation of corporations, the courts are scrutinizing "full-paid" stock of this character much more carefully than heretofore. In a recent pamphlet, 6 it is said: It is not an uncommon practice in organizing corporations having shares with par value, to place such a monetary valuation on properties to be acquired through stock issues, that it seems almost apparent that the properties have been grossly overvalued. In cases of this sort, counsel's reliance is placed upon the statutory provision common in many states to the effect that the judgment of the board of directors as to the valuation placed upon property turned in as payment for stock, is conclusive in the absence of actual fraud in the transaction. The decisions of various courts 6 Justice Ingraham in Insurance Press v. Wire Co., 103 App. Div. (N. Y.) 472, 476 (1905). "Shares Without Par Value," published by the Corporation Trust Corrpany, New York. Ch. 13] TREASURY STOCK 107 on the question, however, have impressed counsel with the importance of requiring directors to act within reasonable limits in arriving at values of this nature. Where a patent or mine, or other property of more or less uncertain value and possibilities is arbitrarily valued by directors at a substantial sum in order to dispose of the question of stock liability, there are still grave legal doubts that their appraisal will stand the test of udicial scrutiny. This is particularly true in New Jersey, where it was formerly supposed that "in the absence of actual fraud in the transaction, the judgment of the directors as to the value of the property purchased shall be conclusive" 7 and this with but little regard as to how this judgment was reached. Recent decisions have, however, rudely disturbed this pleasing supposition. It is now held that the directors' judgment must be based on something more tangible than promoters' statements or vague suppositions. As laid down by the court in a recent case : It was their duty to have acted as an independent board of directors, with full knowledge, would have acted, namely, to have made a careful inventory and appraisement of all property to be purchased with stock or for cash, and to have either issued stock or paid cash, measure for measure, value for value. This they neglected to do, with the result that those whom they sought to protect are not protected, themselves included. 8 In this case, treasury stock supposedly full-paid by property in exchange for which it was originally issued, was held not to have been fully paid thereby, and parties to whom it was subse- quently issued as treasury stock were held liable to the company's creditors for the unpaid balance. V'lff 127. Transfers to Corporation When stock is donated or otherwise transferred to the corpor- ation, the certificates should not be assigned to the treasurer by name, as to "John Wilson, Treasurer," as at a subsequent elec- 7 P. L. (N. J.) 1893, p. 444, as amended by Laws of 1896, p. 294. Holcombe v. Trenton White City Co.. 82 Atl. (N. J.) 618 (1912). io8 CORPORATE LAW [Bk. I- tion the position of treasurer may be filled by some other person and the too definite indorsement may then cause trouble. Such stock is better indorsed to the company itself, as "The Caswell Company," or to its treasurer, as "Treasurer of The Caswell Company." A plan that is sometimes pursued when stock is thus turned over for the benefit of the company, is to assign it to trustees to hold and sell such stock for the benefit of the company, either at their own discretion or under the superintendence of the directors, the funds so received being paid over to the treasurer of the cor- poration. This plan relieves the corporation of all responsibility as to the details of the matter, the transaction not appearing on the company's books until the money from the sale of the stock is turned over. 9 128. How Treasury Stock Is Held When certificates representing treasury stock are received by the corporation, they should bear the proper indorsements, and are then usually turned over to the secretary. This official should enter the transfer in the stock book, cancel the old certifi- cates and return them to the stock certificate book, and, if de- sired, issue new certificates in the name of the corporation or of the official by whom the stock is to be held. It is to be noted that new certificates need not necessarily be issued at all until sales of treasury stock are made, when the certificates represent- ing stock sold might be issued directly to the purchasing party. In such case, until the tune of sale the stock book, in connection with the canceled certificates of the stock certificate book, is sufficient evidence of the status and ownership of such treasury stock. 129. Transfers from Corporation When treasury stock is sold the formalities are simple. The sale being duly authorized by the directors, the treasurer would, 9 Wood v. Sloman, 150 Mich. 177 (1907). Ch. 13] TREASURY STOCK 109 if the stock were held by him and the original certificates had been canceled without reissue, merely give the purchaser an order for the required certificates, or instruct the secretary in writing to issue such new certificates. If the original had been canceled and new certificates issued to the treasurer, this latter official would merely assign one of his certificates, if of the right denomination. If otherwise he would have one broken up, the proper number of shares being issued therefrom to the new pur- chaser, and the unsold remainder being issued to the treasurer. If the certificates had been held in the name of the corporation, the treasurer or such other official or officials as were designated by the board would make the proper assignments, 130. Legal Status of Treasury Stock When its own stock is returned to and is held by the corpora- tion, or by trustees, or by its own officers for the corporation, such stock is not unissued stock, nor do the stockholders as such have any subscription or participation rights when it is reissued. 1 " So long as such stock is held by the corporation, it is inert and can neither vote nor participate in dividends. 11 Should the stock be voted, such action would be illegal and any action or election decided by such vote of treasury stock would be illegal and might be set aside. If the system of accounting logically required that dividends be collected on treasury stock held by the corporation no law would prevent such action, as the money so paid would come directly back into the treasury of the corporation. 131. Stock of Other Corporations Held in Treasury It is to be noted that the comments of the preceding sectiori do not in any way apply to stock of other corporations which may be owned and held in the treasury of any particular corpora- tion. Where the corporation has power to hold the stock of 18 Crosby v. Stratton, 17 Colo. App. 212 (1902); Hartley v. Pioneer Iron Works. 181 N. Y. 73 (1905). " 3 Clark & Marshall on Corp.. I 653!; Vail v. Hamilton, 8s N. Y. 453 (1881); Am. etc.,, Co. v. Haven, 101 Mass. 398 (1869); O'Connor v. Int. Silver Co., 68 N. J. Eq. 67 (1904). HO CORPORATE LAW [Bk. I- other companies, it holds such stock as an individual would do, and has the same right to vote upon it and to receive dividends on it. It is to be noted, however, that a corporation cannot legally hold the stock of another corporation unless specifically auth- orized by statute, as in Delaware, or by charter provision allow- able under the statutes, as in New York. 12 Dunbar v. Amer. Tel. Co., 238 111. 456 (1909); see also discussion in Ch. LVII, "Holding Companies." CHAPTER XIV ifoirfw e'onr'rb SHARES WITHOUT PAR VALUE c '% 132. The Theory of No-Par Shares 1 In his recent work, "The Financial Policy of Corporations," Dr. Dewing of Harvard says : .nth! 4 ? | 30 Jiom rfttow;j one of the distinguished lawyers who drafted the New York statute, expressed himself as follows : The policy of the New York statute is sound. It recognizes that shares in a corporation represent only aliquot interests in its capital, whatever that may be, and that their nominal or par value is no indication of their actual value or of the actual capital of the corporation. It requires the amount of the actual capital of a corporation formed under the law to be stated in the certificate of incorporation, and imposes a severe penalty upon the directors in case of the creation of indebtedness before receiving the prescribed capital. Thus it furnishes to creditors and to the public generally a measure of protection greater than that furnished by the generally prevailing incorporation laws. The use of the share without par value simplifies the cor- poration organization in that the actual investment may be represented by preferred stock of par value and possibly a bond issue, while the contingent interest in the profits is repre- sented by the no-par-value shares. If the business is successful so as to yield returns over and above the agreed compensation to the holders of preferred stock, those who have managed it so well receive an adequate reward in dividends on their no-par- value shares. If it does not succeed so well, the shares being of no published value, a failure to pay adequate dividends is not so much to the public discredit of the corporation. 140. Exchange for Property The use of no-par-value stock avoids the clumsy and of ttimes fraudulent issue of stock for property to make it full-paid. Even Ch. 15] NO-PAR-VALUE SHARES ADVANTAGES 121 where the directors are conscientious about contracts, patents, etc., offered in exchange for common stock, the transaction does not look well on the corporate records and really requires a false statement on the books. The methods by which treasury stock issued for property of uncertain value was made full- paid on the books have always been an embarrassment to the conscientious accountant. 1 141. Prevention of Fraudulent Stock Sales The use of shares without par value prevents frauds on common people by treasury stock being sold below par. As already stated, the public have always been deceived by this procedure, feeling that stock marked $100 must in some way be worth $100, and that if they could get it at a discount they were being let in on the ground floor. Another cardinal advantage would be that of forcing the pros- pective investor to examine the real value of stock, and not be deluded into thinking that there is some necessary connection between the par value and the real intrinsic value. 2 The creation of shares without par value has the advantage of truthfulness. It makes no claims to represent anything but the right to a proportional share in the net profits of the cor- poration, if any, and in event of dissolution, to share in like proportion in any division of the net assets. 142. Corporate Records Are Simplified Issues of shares having no par value are true to the facts and true on the corporate records. With such stock, what is received is entered on the books just as it is paid, and in neither the accounts nor the statements made is there deception or stultification. No question of overcapitalization or under- capitalization can arise. > See Ch. XIII, "Treasury Stock"; also Book -III, Ch. XI, "Capital Stock Without Par Value." 1 i Dewing on Finan. Policy of Corp., p. 14. 122 CORPORATE LAW [Bk I The use of no-par-value shares involves no accounting diffi- culties. The object is to simplify and make possible the issu- ance of stock to represent contingent or speculative interests in the business. This simplicity and directness is shown by the straightforward and comprehensible entries for its issuance. In recording stock of no par value on the books and setting up values' in the statements of assets and liabilities, it does not seem that any difficulties are presented. The capital account should reflect the value at which the stock was issued whether for cash, property or services. The only other account representing a measure of value in the outstanding stock, outside of certain reserve accounts, would be the surplus account. In my opinion this ac- count should at all times represent undistributed net earnings of the corporation. 3 143. Stock Certificates Are Not Deceptive Neither creditors nor purchasers of stock can be deceived by no-par-value stock. The stock certificates do not claim to represent anything except an interest in the company and its possible profits. On the books of the company there is no ficti- tious capital, and creditors know that what they have to look to is only the par value received for preferred stock, plus any amount of cash or property actually paid on the no-par-value stock; that is, the real capital stock of the company is shown by true entries of the actual sales receipts. 144. Stock May Be Sold at Any Price Stock without par value may be sold at any desired price. After the purchaser has paid the agreed price he cannot be involved in any liability. The sale at a low price does not dis- credit the corporation nor does it deceive the buyer. 145. Mergers and Reorganizations Are Simplified The use of no-par-value shares facilitates mergers and reor- ganizations. When the great combinations were formed they 1 F. H. Hurdman, "Capital Stock of No Par Value," Journal of Accountancy, October, :pio. Ch. 15] NO-PAR-VALUE SHARES ADVANTAGES 123 were usually planned so that actual assets were shown by the preferred stock or bonds of the combination and the common stock represented only the expectation of profits. Now this same result can be secured much more accurately by the issue of preferred stock and bonds in conjunction with the issue of stock having no par value; and the excessive capitalization and deceptive issues of common stock that characterized the old system are avoided. 146. Disadvantages So far, the plan seems to have met general favor among those who are using the corporate form for legitimate business and who do not desire to take advantage of ignorant investors. Practice so far seems to have developed no material objection to the use of the no-par-value share by the ordinary corporation. In some cases the shares may be more difficult to sell from the very fact that they carry no dollar indication of their value, or they may be unacceptable because of their novelty, or they may be found objectionable from the standpoint of taxation. All these things are to be considered. 4 That the law should work smoothly in practice is owing to the fact that it was originally drafted by a committee composed of some of the best lawyers in the United States, to meet a specific need and to avoid certain specific corporate ills. Its use has been entirely optional. It has been accepted by the business world on its merits. It has been extensively used and no serious objections have developed. It is not unjustifiable to assume that the plan is successful and that stock with no par value will hereafter be a permanent and esteemed feature of our corporate law and practice. 4 2 Financing an Enterprise, by H. R. Conyngton, p. 395. CHAPTER XVI NO-PAR-VALUE SHARES PROCEDURE 147. Authorization for Issue of No-Par-Value Shares The authorization of shares without par value is a matter of state regulation, and there is some diversity in the statutes of the states that have legislated on the subject. New York was the first state to pass such laws, and the laws on the subject there have been more thoroughly tested by usage than in other states. Such defects as developed in the law have been corrected by amendment. A summary of the essential features of the New York legislation is given below: 1 (Section 19.) Upon formation or reorganization, any busi- ness corporation may provide for the issuance of unvalued shares (other than preferred shares) without any nominal or par value, by stating: 1. The number of shares that may be issued, and if any stock is preferred, the preferences, with the amount, character, and par value of such preferred stock, which shall be $5 or some multiple of $5 up to but not ex- ceeding $100. 2. The amount of capital which it will use in conducting its business. This must be not less than $500 and not less than the par value of the preferred stock, plus $5 ot some multiple of $5 for every share of other (unvalued) stock. Each share of unvalued stock must be equal and each certifi- cate shall have written or printed thereon the number of un- 1 Stock Corporation Law (Consol. Laws, Ch. 59), as amended by Ch. 694, Laws of 1921. 124 Ch. 16] NO-PAR-VALUE SHARES PROCEDURE 125 valued shares represented by it, and the entire number of such shares authorized. The corporation may sell such unvalued shares, (i) for such consideration as may be prescribed in the charter; or (2) at their fair market value, the judgment of the board of directors as to such fair market value being conclusive in the absence of fraud; or (3) the price may be fixed by consent of two- thirds of each class of shares voting at a duly assembled stockholders' meeting. All unvalued stock so issued shall be deemed full-paid and non-assessable. (Section 20.) Such corporation shall not begin business or incur debt until the amount of capital stated in the charter shall have been paid in money or property at actual value. Violation of this prohibition makes directors assenting person- ally liable. (Section 21.) The organization tax on such corporations shall be 5 cents on each share of unvalued stock. The stamp transfer tax shall be 2 cents on each share. The use of the unvalued share is of course optional, the law merely giving the right to organize under its provisions if desired. Few of the other states have passed as satisfactory laws on this subject as the amended laws of New York. Few states have provided for the statement of the amount of capital necessary to begin business, or have made directors who begin business personally liable if they authorize business or the in- curring of debt before the amount stated has actually been paid in. In a state where the law does not authorize corporations to issue no-par-value shares, the privilege may be secured by organization in Delaware, New Jersey, Maine, or some other state where the statutes provide for its issuance, the corpora- tion then doing business in the state which would otherwise be its home state as a foreign corporation. 126 CORPORATE LAW [Bk. I- 148. Organization Tax for No-Par-Value Shares The organization tax varies widely. In New York the rate is 5 cents for each share authorized. This is the same amount that is charged for shares of $100 par value. Massachusetts and Rhode Island also charge 5 cents a share. In many of the states the tax is based on the same theory, and all no-par-value shares are treated as if they were of $100 par value. This is the case in Alabama, Delaware, Illinois, Maryland, Missouri, North Carolina, Pennsylvania, Rhode Island, and Virginia. In New Jersey the organization tax is but i cent a share. 149. Fixing the Selling Price In fixing the selling price, these states vary little. In New York the selling price may be fixed (i) by the charter, (2) by the board of directors, or (3) by the consent of two-thirds of all the stockholders at a duly assembled meeting. In California the selling price must be fixed in the charter. This destroys one valuable feature, the power to sell for such figure as can be obtained. It amounts to fixing a par value for the stock. In most of the states the law authorizes the directors to act, or the charter may authorize them to act, or the stock- holders may authorize the board to fix the selling price. 150. Rights of Holders of No-Par-Value Shares The rights of holders of no-par-value shares are exactly the same as those of a holder of common stock, which have already been set forth at some length. 151. Rights When Preferred Stock Is Outstanding When preferred stock and stock without par value have been issued, the preferred stock takes precedence in dividends and in any distribution of the assets. In such case the no-par- value stock has the same rights as common stock would have if there were no shares without par value. 'SeeCh. XVII, "Stockholders," Ch. 16] NO-PAR-VALUE SHARES PROCEDURE 127 In event of liquidation, after the preferred stock has been paid in full and all accumulated dividends have been satis- fied, if any assets remain they are either surplus profits or else capital contributions from no-par-value stock, and whichever is the case, the holders of the no-par-value stock are entitled each to his proportionate share. If no preference as to assets is given preferred stock, the holders of no-par-value shares would be entitled to an interest in assets proportionate to the amount actually paid in on such shares. If there were surplus profits above the par value of the preferred stock and above the accumulated dividends to preferred stockholders, the surplus profits would be divided among the holders of the no-par-value shares. 152. Certificates of No-Par-Value Stock The New York statute prescribes that "every certificate for such shares without normal or par value shall have plainly written or printed on its face the number of such shares which it represents, and no such certificate shall express any normal or par value of such shares, or express any rate of dividend in terms of percentage of any normal or par value." Unfortunately, the other states that have adopted the plan have failed to make similar provision. In practice it is probable that where such stock is issued, the number of shares authorized would be printed plainly on the certificate, otherwise the pur- chaser would not know what fractional interest in the profits he was buying. If 1,000 shares are issued it would be necessary, in order to pay dividends of $8 a share on the no-par-value shares, for the corporation to make surplus profits (above anything required to pay preferred dividends) of $8,000; while if there were 10,000 shares of no-par-value stock, it would take $80,000 to pay the same dividend. In other words, each share of unvalued stock means merely a fractional interest in future profits, and the more there are 128 CORPORATE LAW [Bk. I- the smaller the fraction; hence the purchaser should be in- formed as to just what the fractional interest will be. 153. Annual Taxation for Domestic Corporations For purposes of taxation, the usual plan is to account that each no-par-value share has a par value of $100. In New York the income tax applies to all corporations alike and the character of stock issued is immaterial. In New Jersey the annual tax is 3 cents a share up to 20,000 shares, above that the tax de- creases to 2>^ mills for all above 50,000 shares. In Colorado, for taxation purposes, shares are deemed to be of the par value of $i each. In Maine, 5 mills for each share, with a minimum of $10. 154. Taxation When Operating in Other States When corporations with shares without par value under- take to operate as foreign corporations in states other than the state of incorporation, they are usually treated as if the no- par-value shares were shares for $100. In a few states they have been refused recognition. In Missouri and Kansas, as already stated, suit was brought, and the courts decided that they should be admitted to do business without discrimination. 3 Curiously enough, each of these states has within the past year authorized the incorporation of corporations w'th no-par-value stock. It is said that at the present time South Carolina and Washington are the only states where authority to do business would be refused to a corporation with no-par-value shares. 155. Preferred No-Par-Value Stock In issuing preferred stock without par value, it is necessary to state not only the preference in dividends, but also what preferences, if any, preferred stock is to have in case of liqui- dation. If no preference is given in case of liquidation, the preferred share and the common share would participate on the See { 136. Ch. 16] NO-PAR-VALUE SHARES PROCEDURE 129 same basis in whatever assets remained after paying all debts. The preference in dividends would have to be stated in dollars and not as a percentage. 156. Accounting Entries 4 If common stock or preferred stock having a par value is issued, it is issued for its face value and the amount is credited to a capital stock account. If stock without par value is issued the amount received, whatever it may be cash, property, or services is likewise credited to a capital stock account. Any profits made go to the capital or surplus account, increase the value of the outstanding stock, and represent the amount available for dividends. As the amount received from the sale of no-par-value stock may vary, successive sales may change the value of all the no- par-value stock outstanding. For example, if 1,000 shares were sold at $10 per share, and then a year later 1,000 more shares were sold for $20 per share, there would be outstanding 2,000 shares. Then ignoring any profits or losses resulting from opera- tions, this stock would be worth $15 per share. Then two years later, in time of depression, if the corporation were compelled to sell 3,000 shares for $5 a share, there would be outstanding 6,000 shares worth $7.50 each. In like manner the profits or losses of the corporation cause fluctuations in the value of the stock. Thus, if 3,000 shares were sold for $45,000 but in managing the business one-third of the assets were lost, the outstanding stock would be worth but $10 a share. All this is, of course, just as true for stock with a par value. Its book value changes with every change in the net worth of the business. These changes are not so easily seen as in the case of no-par-value stock, because obscured by the fixed and meaningless par value. See Book III, Ch. XI, "Capital Stock Without Par Value." 130 CORPORATE LAW [Bk. I- 157. Valuing No-Par-Value Shares When for purposes of paying taxes or for any other reason it is necessary to ascertain the value of no-par-value shares, it may be done by ascertaining the net worth of the corporate business, and deducting from it the face value of any preferred or common stock with par value, and any preferred stock without face value entitled to a specific amount on liquidation, and dividing the remainder by the entire number of no-par- value shares outstanding. The result will equal the book value of each share at the time. If new stock is to be sold at any time, it would not ordinarily be sold at less than the book value of the stock already outstanding. Part IV Corporate Control CHAPTER XVII STOCKHOLDERS 158. General An investor in a corporate enterprise becomes a stockholder or shareholder. He may become a stockholder either by original subscription or later by buying stock from a stockholder or from the corporation. The shareholders are persons who are interested in the operation of the corporate property and franchises, and their shares actually represent undivided interests in the corporate enterprises. The corporation has the legal title to all the properties acquired and appurtenant; but it holds them for the pecuniary benefit of those persons who hold the capital stock. They appoint the persons to manage its affairs, they have the right to share in surplus earnings and, after dissolution, they have the right to have the assets re- duced to money and to have them ratably distributed. Each share represents a distinct interest in the whole of the corporate prop- erty. 1 In the active affairs of the corporation the stockholders occupy a position of minor importance. They own the stock of the corporation and, through that ownership, the corpora- tion itself with all its belongings. Their control of the organiza- tion and their management of its affairs is, however, indirect and somewhat removed. The profits of the business belong to them, but its actual management and the general control of the 1 In re Bronson, 150 N. Y. I (1896). 132 CORPORATE LAW [Bk. I- corporation are in the hands of the directors, with whom the stockholders, either individually or collectively, cannot directly interfere. The functions of stockholders are exceedingly limited. .The theory of a corporation is that stockholders shall have all the profits, but shall turn over the complete management of the enter- prise to their representatives and agents, called directors. Accord- ingly there is little for the stockholders to do beyond electing directors, making by-laws, increasing or decreasing the capital stock, authorizing amendments to the charter, and dissolving the corporation. 2 5 150. Functions 8 oy ina > i r, i ->; -i 0:; :, n! a/: As already intimated, the functions of the stockholders are few and simple. They assemble once a year in annual meeting to listen to reports, elect directors, and discuss the general affairs of the company. On rare occasions they are assembled for particular action in special meeting. If the charter is to be amended, they are usually required to act. If all the assets of the corporation are to be sold, they must generally be called upon to sanction the proceeding. In some states their consent is required to validate corporate mortgages. They would act on any proposed liquidation of the corporation. By charter provisions, their consent may be necessary to other proposed action. One other most important function pertains to the stockholders: the right to make, amend, and repeal the by-laws. The active connection of the stockholder with his corpora- tion is, under normal conditions, limited to the functions specified. The further control and direction of the corporate organization and its property and business are left entirely to the directors he has elected. 1 60. Rights The rights of stockholders discussed in the present chapter are those general rights which are incident to the ownership of : 3 Cook on Corp., J 708; see also { 711. Ch. 17] STOCKHOLDERS 133 common stock in a stock corporation. The holders of preferred stock have all these same rights in addition to their special rights unless denied, varied, or restricted by the terms of issue. Every stockholder has the right to transfer stock freely, to have his name appear as that of a stockholder upon the stock books of the company, and, when his stock is full-paid, to have a stock certificate. In addition, the ordinary individual rights of a holder of stock are: i*. To be notified of and participate in all stockholders' meetings in person or by proxy, and usually, for each share of stock standing in his name upon the books of the corporation, to cast one vote at any election of directors or upon any question that may come before such meeting. 2. To share, in proportion to the amount of stock owned, in all dividends declared on the common stock, and to subscribe in like proportion for any increase of the capital stock. 3. In event of the dissolution of the corporation, to share in proportion to the amount of stock owned in any assets remaining after the corporate debts and obliga- tions have been paid. 4. To inspect the corporate books and accounts. These rights are discussed in detail in the sections which follow. 161. (i) Notice of Meetings and Voting As a matter of common or statutory law the stockholder is entitled to due notice of all stockholders' meetings. If the time of the annual meeting is specified in the by-laws, this in itself is presumed to be notice to the stockholder, and the fact that he does not receive a personal or mail notice and is for this reason not present, does not affect the validity of such meeting. 134 CORPORATE LAW [Bk. I- But where, as in New York, the statute requires publication of the notice of the annual meeting, or where the by-laws provide how notice shall be given, the statute or the by-laws must be complied with unless waived by all of the stockholders. Unless expressly denied in some way, every stockholder, whether his stock be common, preferred, or special, has the right to participate in and vote at all meetings of stockholders. Usually he is entitled to cast one vote on all matters passed upon at stockholders' meetings for each share of stock standing in his name upon the books of the corporation a right secured to him in a majority of the states by express statute provision. In other states the right, if desired, should be definitely set forth and secured by proper provision in the charter or by-laws. If this is not done, the common law prevails, under which every stockholder is entitled to one vote on all matters passed upon by the stockholders, regardless of the amount of stock he holds. 3 If the statutes make no provision as to voting, the matter may be regulated by either charter or by-laws. In some few states, as in Washington and Maine, the statutes expressly authorize such regulation by the by-laws. In others, as in Connecticut, Delaware, New Jersey, and Nevada, the statutes provide the method that shall be followed in voting unless otherwise prescribed by charter or by-laws. In these states it is possible to deprive entirely certain classes of stock of the voting power. It is not unusual to provide that preferred stock shall have no vote where the holders of the common stock are the active stockholders and the preferred stock represents investments by outsiders. In California the statute forbids any such denial of voting power. The statutes usually prescribe that voting at elections of directors shall be by ballot. Where no special method of voting is prescribed by statutes, charter, or by-laws, it may be by call of roll, by ballot, or by any other method that will properly and legally indicate the sense of the meeting. If all are agreed, Taylor v. Griswold, 14 N. J. L. 222 (1834). Ch. I?] STOCKHOLDERS 135 it is always permissible to instruct the secretary to cast the single ballot of the meeting for the election of specified candi- dates for directors, or for or against any other measure properly before the meeting. As between the corporation and its members, the right to vote and usually also the number of votes a stockholder is entitled to cast are determined by the stock books of the cor- poration. 4 The possession or non-possession of a stock certifi- cate is immaterial, as the right to vote is evidenced positively by the record of the stock books. The right to vote by proxy is generally given by express provision of either the statutes or by-laws, though in some states the right is secured by constitutional provision. It did not exist at common law. 5 Trustees may vote upon the stock held in their names as trustees. An executor or administrator may vote upon the stock belonging to the estate even though standing in the name of the deceased party. In the absence of disagreement, any partner may vote stock standing in the partnership name. A corporation holding stock of another corporation may vote such stock through duly authorized agents. A receiver usually votes stock in his possession. When stock is held jointly or in com- mon, as in the case of a partnership or where there are two or more trustees or executors, all must agree on the vote or other- wise it will be lost. 6 162. (2) Dividends and Participation Rights Save when affected by the issue of some preferred or other special stock, each stockholder has the right to share in divi- dends with the other stockholders of his corporation propor- tionately to the number of shares of stock he holds, and there 4 Commonwealth v. Dalzell, 152 Pa. St. 217 (1893); State v. Ferris, 42 Conn. 560 (1875); In re Argus Printing Co., I N. D. 434 (1891). 6 Taylor v. Griswold, 14 N. J. L. 222 (1834); Philips v. Wickham, i Paige (N. Y.) 590 (1829); Commonwealth v. Bringhurst, 103 Pa. St. 134 (1883). 8 Tunis v. Hestonville. etc., Co., 149 Pa. St. 70 (1892). 136 CORPORATE LAW (Bk. I- must be no discrimination of any kind in the declaration or the payment of these dividends. Holders of preferred stock, unless otherwise expressly pro- vided, are entitled in any year to payment of their preferred dividends before any dividends are paid the common stock, and thereafter, as soon as the common stock has received an equal dividend, to participate equally with the common stock in any further dividends declared in that year.? Unless other- wise expressly provided, dividends on preferred stock are cumu- lative, and current dividends on preferred stock and all arrears must be paid before dividends may be paid on the common stock. 8 If the capital stock of a corporation is increased, each stock- holder has the right to subscribe for the new stock proportion- ately to his holding of the old outstanding stock. 9 Thus if he holds 10% of the outstanding stock and the capital stock is increased, he has the privilege of subscribing for 10% of the new stock. This rule applies to any actual increase of stock, but not to a sale of treasury stock, nor usually to stock which is part of the original capitalization but which has not yet been issued. 10 If, however, this unissued stock has been held for a considerable period of time and is then issued, the stockholders should all have an equal opportunity to subscribe therefor." Holders of preferred stock have the same rights of subscription as do holders of common stock, unless expressly denied them by the provisions which created the preferred stock. The right of subscription is sometimes of considerable value, as where a new issue of stock is authorized at a fixed price and this price advances before the day of sale. Sternbergh v. Brock, 225 Pa. St. 279 (1909); Sterling v. H. P. Watson Co., 241 Pa. St. 105 (1913). 8 Fidelity Trust Co. v. Lehigh Valley R. R. Co., 215 Pa. St. 610 (1906); Boardman v. Lake Shore Ry. Co., 84 N. Y. 157 (1881). Way v. Am. Grease Co., 60 N. J. Eq. 263 (1900); Electric Co. v. Edison, etc. Co.. 200 Pa. St. 516 (1901); Stokes v. Cont. Trust Co., 186 N. Y. 285 (1906). "Crosby v. Stratton, 68 Pac. Rep. 130 (1902); Archer v. Hesse. 164 App. Div. (N. Y.) 493. 497 (1914). 11 Electric Co. v. Edison El. Co., 200 Pa. St. 516 (1901). Ch. 17] STOCKHOLDERS 137 163. (3) Distribution of Assets on Dissolution Each stockholder is entitled to share equally in any dis- tribution of the assets of the corporation, whether on final dis- tribution or on some partial intermediate distribution. Under whatever proceedings a corporation is dissolved, the general rule holds that all corporate obligations and the expenses of the proceedings must first be discharged, and that any remaining assets must be distributed among the stockholders, the same rules applying as to equality of payment, of time, and of kind, as in the case of dividends. 12 In the absence of any express provision to the contrary, common and preferred stock share alike in the distribution of assets. 13 If by its terms preferred stock takes precedence, it must first receive any assets available for distribution up to its full face value. The common stock then receives any remain- ing assets up to its full face value. If any balance of assets still remains, both common and preferred stock participate therein alike, unless otherwise expressly provided. 164. (4) Inspection of Books Under the common law every stockholder had the right to inspect the books and accounts of the corporation in person or by agent, and to make abstracts or copies therefrom without restriction, save that the examination be made at a reasonable time and for a proper purpose. This is the rule in states where there is no statutory regulation. 14 In some states the statutes provide that a stockholder de- siring to examine the books of account or the records of his corporation must, if refused, secure an order of court for such examination, which will be granted only when he shows some good reason therefor. 15 This reason must be substantial and 12 2 Cook on Corp., 5 641. 13 Coltrane v. Building Assn., no Fed. Rep. 281 (1901). 14 Ranger v. Champion Cotton Press Co., 51 Fed. 61 (1892); Huylar v. Cragin Cattle Co., 40 N. J. Eq. 392 (1885); Matter of Steinway, 159 N. Y. 250 (1899); State v. Jessup & Moore Paper Co., 88 Atl. (Del.) 449 (1913); State v. Insurance Co., 169 Mo. App. 354 (1912). "Varney v. Baker, 194 Mass. 239 (1907); Kuhbach v. Irving, etc. Co., 220 Pa. St. 427 (1908). I3 8 CORPORATE LAW [Bk. I- must be for the specific purpose of investigating some matter concerning the management of the corporation in which his rights as a stockholder are or may be affected injuriously. 16 This restriction of the right is not unreasonable. It is obvi- ous that it would be impracticable in a large modern corpora- tion with its multitude of scattered stockholders, to allow these to come in at any time and make an examination of the books. The interference with the regular business would in itself be intolerable, but beyond this the right might be so used in the interest of business competitors as to render it destructive of the interest of the stockholders at large. In some states statutes have been passed which enlarge the stockholders' usual right to examine the corporate records, and in a few states the right has been considerably extended. These statutes give the stockholders the right to inspect the corporate records irrespective of the purpose for which the inspection is sought. 17 In some states this right extends to all of the cor- porate records, and in most of the states there is a statutory right to inspect the stock and transfer books. 18 In New Jersey the courts hold that even this right cannot be enforced unless the stockholder can show some reason for his inspection "ger- mane to his status as a stockholder." 19 In many of the states a statutory penalty is imposed on the corporate officers who refuse a stockholder the right of inspection prescribed by the statutes. In such cases the stockholders' rights are not difficult of enforcement. 20 Where the right to examine the corporate records exists, it includes the right to make copies and abstracts. 21 It also in- cludes the right to be accompanied by the party's attorney or expert accountant, or the inspection may be delegated to one or both of these. 22 16 Phoenix Iron Co. v. Commonwealth, 113 Pa. St. 563 (1886). 17 Poor v. Yarnell, 153 Pac.(Cal.)976(i9is); Baumrucker v. Jones, 172 111. App. 188 (1912). 11 Lozier v. Saratoga, etc. Co., 59 App. Div. (N. Y.) 390 (1901); State v. Middlesex Banking Co., 87 Conn. 483 (1913); Wilkington v. Bradley, in Me. 384 (1914). "State v. National Biscuit Co., 54 Atl. (N. J.) 241 (1903). 20 Lozier v. Saratoga, etc. Co., 59 App. Div. (N. Y.) 390 (1901). 21 Cincinnati Volksblatt Co. v. Hoffmeister, 62 O. St. 189 (1900). 22 People v. Nassau Ferry Co., 86 Hun 128 (1895); State v. Insurance Co., 169 Mo. App, 354 (1912); Varney v. Baker, 194 Mass. 239 (1907). Ch. 17] STOCKHOLDERS . 139 Lists of stockholders in the larger corporations have an actual money value, and in New York the practice of acquiring a share of stock in one of the large companies for the sole pur- pose of using the right thus obtained to copy the list of stock- holders and of then selling the list, became so flagrant that in 1916 the legislature amended the law so as to limit the right of inspection to persons who have been stockholders of record for six months, or to persons holding stock equal to 5% of all the outstanding shares. The statute expressly provides, however, that nothing therein shall impair the right of the courts to compel by mandamus the production of the stock book for the examination of any stockholder upon good cause shown. 165. Special Charter Rights In many states special provisions for the regulation of the business and the conduct of the affairs of the corporation may be inserted in the corporate charter. Where this privilege exists, righft not usually belonging to the stockholders of a corporation may be thereby secured. Thus, stock may be classified so as to give the minority stockholders unusual voting powers; minority representation may be insured by cumulative voting; the right to examine books may be denned and ex- tended; the right to be present at directors' meetings may be given; it may be provided that profits when they exist shall be declared as dividends at regular intervals, or the power of the directors to pay salaries, contract debts, sell corporate property, and the like, may be restricted. Unfortunately, those who incorporate a company usually expect to be majority stockholders and to control the corpora- tion, and therefore do not concern themselves to protect minority holders. If those who buy stock would decline to invest where minority rights are not protected, there would soon be more consideration for the smaller stockholders. It should be noted that special provisions incorporated in 140 . CORPORATE LAW [Bk. 1- the'charter are difficult of repeal or amendment. For this reason only those which are expressly desired to be permanent should be made the subject of charter provision. Less important pro- visions are better included in the by-laws, where they may be changed when necessary with less formality. 166. Statutory Rights In most of the states the usual common law rights of stock- holders discussed in the preceding sections have been re- enacted in the statutes. In many states the statutes give the stockholders additional rights, some of which have already been mentioned. Thus in New York, Kansas, North Dakota, and a number of other states, stockholders may call for statements and reports from the corporate officials. In California and Washington they may inspect' mines owned by the corporation. In Delaware any stockholder may demand a statement of amounts paid on capital stock and the amount of stock issued. In a number of states meetings for election of directors may be compelled by following prescribed procedure. 167. Powers The individual stockholder, no matter how large his holding, has no power as a stockholder to interfere in the lawful manage- ment of the company or its business. 23 If the directors take, or are about to take, any illegal or wrongful action, he may restrain them by appeal to the courts. If, however, the action taken or about to be taken is in itself not unlawful but merely objectionable to him, his only recourse is to induce, if he can, a majority of the stockholders to act with him in holding a duly assembled stockholders' meeting, when the by-laws may be amended or such other remedial steps be taken as may be possible. The collective powers of the stockholders apply to but few matters and may be summarized as follows: - a Demarest v. Spiral, etc. Tube Co., 71 N. J. L. 14 (1904); Continental Securities Co. v. Belmont, 206 N. Y. 7, 16 (1912). Ch. 17] STOCKHOLDERS 141 1. Amendment of charter. 2. Adoption, repeal, or amendment of by-laws. 3. Election of directors. 4. Sale of entire assets. 5. Dissolution of corporation. 6. Exercise of any special charter powers. 168. (i) To Amend Charter A charter is a contract between the state and the stock- holders of the particular corporation, and the assent of both the state and these stockholders is a prerequisite to its amend- ment. In most of the states the statutes provide that the charter may be added to or amended, usually in certain pre- scribed details or matters, at a duly assembled meeting, by the action of a specified proportion of the stockholders ranging upward from a bare majority to three-fourths of the outstand- ing stock. 169. (2) To Adopt, Repeal, or Amend By-Laws The adoption or amendment of by-laws is one of the com- mon law powers of the stockholders. If no provision is made otherwise, the power to adopt, amend, and repeal by-laws rests with the stockholders alone, 24 who must, to exercise this power, be duly assembled in a meeting at which such action can be lawfully taken. 25 If the charter or by-laws do not otherwise prescribe, the by-laws may be adopted, amended, or repealed at any regular meeting of the stockholders or at any special meeting where such proposed action has been duly announced. There is some question whether by-laws may be adopted or amended without previous notice at the annual meeting held in accordance with statutory requirements, unless the charter or by-laws expressly so provide. 26 If the power to adopt by-laws is delegated to the directors, 14 Angel & Ames on Corp., | 327. ' North, etc. Co. v. Bishop, 103 Wis. 492 (1809). * Bagley v. Reno, etc., Co., 201 Pa. St. 78 (.1902). 142 CORPORATE LAW [Bk. I- this does not, unless expressly so stated, confer on them the exclusive right to make by-laws nor empower them to repeal by-laws enacted by the stockholders. 27 170. (3) To Elect Directors The election of directors is one of the common law powers of stockholders which has been re-enacted in the statutes of most of the states. In all corporations for profit the power exists without specific statutory authority. 28 In the absence of other provision, the stockholders have the right to fill vacancies in the board of directors. Ordinarily, however, either by statute or by-law provision this power is given to the board. 171. (4) To Sell Entire Assets A solvent corporation can sell its entire assets only by the unanimous consent of all its stockholders. 29 Where, however, a corporation is financially involved or likely to become so, the sale of all its property may be made in any manner that will secure a fair return, by authorization of a majority of the stockholders. 30 Also, if the statutes or charter so provide, the entire assets of a corporation may be sold by action of a majority of the stockholders, or by majority action of the directors, the prescribed formalities being duly observed. 31 172. (5) To Dissolve the Corporation "It is an unquestioned rule that all the stockholders, by unanimous consent, may effect a dissolution of the corporation by the surrender of the corporate franchises." 32 Where the 17 See |{ 231, 253, 291; Stevens v. Davison, 18 Gratt. (Va.) 819 (1868). n Re Union Ins. Co., 22 Wend. 591 (1840). "Abbott v. American Hard Rubber Co., 33 Barb. 578 (1861); People v. Ballard, 134 N. Y. 269 (1892); Eldred v. American Palace Car Co., 96 Fed. Rep. 59 (1899); 99 Fed. Rep. 168 (1900). '"Sewell v. East, etc. Co., SO N. J. Eq. 717 (1892); Skinner v. Smith, 134 N. Y. 240 (1892); Hayden v. Official Hotel Red-Book, etc. Co., 42 Fed. Rep. 875 (1890). 31 Republican, etc. Mines v. Brown, 58 Fed. Rep. 644 (1893); Peabody v. Westerly Waterworks, 20 R. I. 176 (1897). ** 2 Cook on Corp., 629. Ch. 17] STOCKHOLDERS 143 corporation is insolvent or is in danger of becoming insolvent, and is unable to further conduct its corporate business, a majority of the stockholders may effect its dissolution. This is the extent of the power of the stockholders under the common law. 33 Statutory provisions, however, exist in a majority of the states prescribing procedure whereby dissolution may be had by action of a stated majority of the stockholders. 173. (6) Special Powers In many states special powers are conferred upon the stock- holders by express statutory provision. Thus in Kentucky, Maine, and some other states, it is provided that corporations may merge or consolidate with others upon the consent of a prescribed majority of the outstanding stock, usually with a provision for the appraisement and purchase of the stock of any dissenting stockholder. In New York, Pennsylvania, and some other states it is provided that any mortgage of corporate property must be authorized by a vote of the stockholders. In several states, as California and Montana, directors may be re- moved by a two-thirds vote of the entire stock. In the states where special provisions may be inserted in the charter, as in New York, Delaware, and South Dakota, it is possible to extend the powers of stockholders far beyond their usual scope. 174. Liabilities The liabilities of stockholders as such are few usually only to pay the full par value of the stock subscribed for or purchased by them. If subscriptions are not paid according to their terms, or when subscriptions are unconditional as calls are made by the directors, the corporation may either bring suit to collect unpaid amounts, obtain judgment and levy on the stock if necessary, 34 or, where the statutes give such power, may forfeit " Berry v. Broach, 6s Miss. 450 (1888); Price v. Holcomb, 89 Iowa 123 (1893). M Nashua Bank v. Anglo-Am. Co., 189 U. S. 221 (1903). 144 CORPORATE LAW [Bk. I- the delinquent stock. If the corporation does neither, the lia- bility of the stockholder on his unpaid stock still remains for the benefit of creditors of the corporation in case of its in- solvency. 35 When the statutory forfeiture of stock for unpaid calls is enforced in good faith, a stockholder who is thus deprived of his stock is released from further liability to the corporation and its creditors. When stock is so forfeited, it is necessary to observe the prescribed statutory formalities carefully, as other- wise the proceedings may be set aside and the corporation be liable in damages. 36 As a rule, corporate creditors must first proceed against the corporation for the collection of their claims. If they secure judgment against the corporation and are unable to collect from it, they may then proceed against any stockholder who has not paid in full for his stock. 37 If, however, the corporation has been dissolved or is notoriously insolvent, creditors may some- times proceed directly against the stockholders of the corpora- tion. 38 If the corporation goes into the hands of an assignee, a receiver or a trustee in bankruptcy, it is the duty of that official to collect all unpaid subscriptions. 39 The fact that other stockholders have not paid their sub- scriptions does not avail a stockholder as a defense against payment of his own subscription. Nor has he any claim against these other subscribers. When, however, payment of his sub- scription is enforced by corporate creditors, the conditions are different. A corporate creditor need not, as a rule, proceed against or join all the stockholders whose subscriptions are unpaid, but may collect from any one or more of them up to the full amount due on their stock if his claim amounts to so much. In such case, as the corporate debts are a joint obliga- * Scovill v. Thayer, 105 U. S. 143, 156 (i88i);-Hawkins v. Glenn, 131 U. S. 319. 334 (1888). * Lewey's Island R. R. Co. v. Bolton, 48 Me. 451 (1860). 37 Wetherbee v. Baker, 35 N. J. Eq. 501 (1882). 88 Terry v. Tubman, 92 U. S. 156 (1875); Terry v. Anderson, 95 U. S. 628, 636 (1877.) In re Crystal Spring Co., 96 Fed. 945 (1899); Scovill v. Thayer, 105 U. S. 143 (1881). Ch. 17] STOCKHOLDERS 145 tion to be borne by all the delinquent stockholders in proportion to the amounts due on their stock, any subscribers who are compelled to pay more than their due proportion can compel contribution from other delinquent stockholders up to their pro- portion of the debts paid. 40 175. Liabilities of Purchasers of Stock The stockholder who is not an original subscriber, but who purchases outstanding stock in good faith with the understand- ing or express statement that it is full-paid, and particularly when the certificates are so marked, does not incur any liability either to the corporation or its creditors even though the sub- scription price or the par value of such stock has not been paid in to the corporation. In any such case the unpaid liability on the stock either remains with the transferrer or is lost. 41 When, however, a purchaser takes unpaid stock with a knowledge of the conditions, the liability for any call already made, even though the payment date of such call has not yet arrived, remains with the transferrer, but the transferee is liable for any subsequent calls. 42 176. Statutory Liabilities of Stockholders The general rule is, however, modified by statute in many of the states. Thus in Oregon and Tennessee the liability on un- paid stock remains with the transferrer, while in Kentucky it continues with the transferrer for two years from the date of transfer, and in Maine and Mississippi for one year. In Wis- consin the liability may be shifted to the transferee with the consent of the corporation, but the liability of the seller con- tinues notwithstanding for six months after the transfer. In Nebraska the liability follows the unpaid stock. In Illinois both transferrer and transferee are liable. 40 4 Thompson on Corp., { 3816. ' Brant v. Ehlen, 59 Md. I (1882); Rood v. Whorton, 67 Fed. 434 (1895). Webster v. Upton, 91 U. S. 65 (1875). 146 CORPORATE LAW [Bk. I- The common law liability of holders of unpaid stock for any unpaid portion of its par value is confirmed by statute in most states of the Union. In a few states this common law liability has been extended, and in a number of states additional liabili- ties are imposed. These subsequent or additional liabilities extend to all stockholders whether their stock is full-paid or otherwise. This liability on unpaid stock may, by agreement of the cor- poration, be terminated as between the corporation and its stockholders, but would still exist as between these stockhold- ers 43 and creditors of the corporation, and on the insolvency of the corporation would become immediately effective. 44 In a few states there are additional liabilities. Thus in Minnesota the stockholder is liable, in case the corporation becomes insolvent, for a further amount equal to his original subscription, that is, equal to the par value of the stock he holds. The corporation cannot collect this additional amount, but in case of its insolvency any creditor of the corporation may en- force payment. This double liability formerly existed in several other states, but is now found in Minnesota alone. In Cali- fornia each stockholder is liable for any portion of his subscrip- tion that is not paid, and is further liable for such proportionate part of the corporate indebtedness incurred during the period in which he is a stockholder, as his stock bears to the total capitalization of the corporation. 43 Goodnow v. Amer. Writing Paper Co., 66 Atl. (N. J.) 607 (1907); Bostwick v. Young, 118 App. Div. (N. Y.) 490 (1907); affd., 194 N. Y. 516 (1909). 44 Merchants Mutual Adjusting Agency v. Davidson, 23 Cal. App. 274 (1913); Southwortb v. Morgan, 205 N. Y. 293 (1912); Dickerman v. Northern Trust Co., 176 U. S. 181 (1900). CHAPTER XVIII DIRECTORS 177. Powers of Directors The board of directors is the managing body of the corpora- tion. Unless restricted by statute, charter, or by-laws, it exer- cises the active controlling power in all corporate business. "The board of directors and not the stockholders, nor the president, secretary, treasurer, or other agent, is the original and supreme power in corporations to make corporate contracts." 1 The directors are the embodied power of the corporation, so con- stituted by the mere fact of their appointment. 2 The stock- holders can neither force the directors to act nor restrain them from acting save by charter or by-law provision unless the omission in the one case or the act in the other is so glaringly unjust or injurious to the interests of the stockholders as to warrant an appeal to the courts. The powers of the board do not, however, extend beyond the purposes for which the corporation was formed. Thus the sale of the entire assets, the dissolution of the corporation, or a radical change of its business are not within the unsupported power of the board. Also the statutes in the different states restrict in greater or less degree the common law powers of the board. Thus, as a rule, directors are not allowed to issue bonds or to mortgage corporate property unless expressly authorized thereto by the stockholders. Also the absolute authority of the board may always be limited by charter or by-law provisions. On the other hand, the powers of directors are sometimes extended by 1 3 Cook on Corp., {} 709, 712. * Landers v. Frank St. M. E. Church, 114 N. Y. 626 (1889). 147 148 CORPORATE LAW [Bk. I- charter or by-law provisions, or by the statutes, in the latter case mainly as to adoption of by-laws. 178. The Power of the Directors Collective, Not Individual The authority of the directors may be exercised only as a board in duly assembled meeting with a quorum present. 3 A single director, as such, has absolutely no authority over the corporate affairs. 4 He may be appointed by the board to man- age some feature of the corporate business, or as managing director may practically control the corporate affairs, but in any such case his powers are only those which are delegated to him by the board and are limited strictly by the terms of his appoint- ment. 5 As a knowledge of the corporate affairs is essential to the proper discharge of his duties, he has a right to inspect the records and the property of the corporation and to familiarize himself with its operations. 6 He is also entitled to attend any meeting of the standing committees, 7 to be notified of all special meetings of the board, to attend all board meetings, and to be heard, if he so desires, on all matters coming before any such meeting. 8 If he discovers anything wrong in the conduct of the corporate affairs, he has no individual power to right it, but must present the matter to the board for its action. 179. Directors Trustees for the Stockholders Directors of a corporation are virtually trustees for the body of stockholders, and must exercise the same care and diligence in the conduct of the corporate affairs as prudent business men would exercise in the conduct of their own affairs. 9 As trustees, they must have no interest adverse to the interest of the com- * North Hudson, etc. Assn. v. Childs, 82 Wis. 460 (1892); Ames v. Goldfield Merger Mines Co., 227 Fed. 292, 301 (1915). 4 Alabama Nat. Bank v. O'Neil, 128 Ala. 192 (1900); Gaynor v. R. R., 189 Pa. St. 5 (1899). * 3 Clark & Marshall on Corp., } 690. People v. Throop, 12 Wend. (N. Y.) 183 (1834); Rosenfield v. Einstein,'46 N. J. L. 479. 484 (1884). 7 Western Ry. v. Rushout, 5 De G. & Sm. 290 (1852). 8 Metropolitan, etc. Co. v. Domestic, etc. Co., 44 N. J. Eq. 568 (1888); Curtin v. Salmon, etc. Co., 130 Cal. 345 (1900); Broughtor v. Jones, 120 Mich. 462 (1899). 3 Cook on Corp., { 648; Elfiott v. Baker, 194 Mass. 518 (1907); Gen. Rubber Co. v. Benedict. 215 N. Y. 18 (1915). Ch. 18] DIRECTORS 149 pany. Too often directors are not as scrupulous as they should be in this particular. 180. Appointment and Removal of Officers and Agents The authority of the board to appoint and remove officers and agents of the corporation is not a common law power, but must be given it by statute, charter or by-law provision. Unless this is done, the power belongs to and may be reserved by the stockholders. The subject is treated more fully in the following chapter. 181. Appointment of Standing Committees Standing committees are those permanent committees of the board to which some measure of its discretionary power has been delegated. The board has general power to appoint standing committees. Their purpose is twofold : (i) to secure the prompt, decisive action of a small, easily assembled body, and (2) to obviate the necessity for frequent meetings of the board. As the discretionary powers of the board itself are delegated to standing committees, they must be composed of members of the board. Their powers are exercised during the interim be- tween the board meetings; and within the limits of their author- ity they act with the same binding force and effect as the board itself and their contracts are not subject to revision by the board. 10 When authorized thereto by the charter or by-laws of the corporation, the power of the board to delegate its authority to properly constituted standing committees is well established. How much power should be so delegated is to be determined by the nature and conditions of the company's business. It is but rarely that more than two standing committees are deemed necessary. If but one committee exists, it is usually termed the "executive committee," and its powers are ordinarily those of the board. If two committees are appointed, the second 10 Corpus Juris, II 1863, 1865; Hayes v. Canada, etc., Co., 181 Fed. Rep. 289 (1910). 150 CORPORATE LAW |Bk. I- is usually designated the "finance committee," and to this com- mittee is given direct supervision of the corporate finances and accounts; all general matters remaining in charge of the execu- tive committee. The matter is, however, one to be regulated by the charter or by-laws, and variations of the usual arrangements are frequent. When standing committees are appointed with the usual powers, they are the real managing bodies of the corporation, the board merely receiving their reports and supervising their opera- tions. In a small corporation or any corporation with a compact, easily assembled board, they are as a rule an unnecessary and even undesirable complication. They are advantageous only when the board is so large or so scattered as to be difficult of assembling, or when for other reasons the business of the corpora- tion cannot be properly transacted by the board as a whole. Not infrequently the standing committee is used as a device by which a few men practically manage the affairs of the corpora- tion, the board being superseded by the standing committee. The membership of standing committees is seldom less than three, nor, save in very large corporations, more than five. To increase the number renders the standing committee unwieldy and defeats the purpose of its creation. 182. Adoption of By-Laws Originally the stockholders were supposed to express their wishes as to the management of the corporation through the by- laws, and the directors to exercise their powers in subordination thereto. 11 Of late years, however, in many states the statutes confer upon the directors more or less extended power to adopt by-laws. In some of these states the by-laws adopted by the directors -must be either in harmony with the by-laws passed by the stockholders, or subject to their revision. In Illinois the board is given the sole and entire right to adopt by-laws. Also 11 North Milwaukee, etc.. Co. v. Bishop, 103 Wis. 492 (1899); Morton, etc., Co. v. Wysong, /.i Ind. 4 (1875). Ch. 18] DIRECTORS 151 in some other states they are given power to make by-laws for their own government. When the stockholders have by by-law provision delegated the power of making by-laws to the directors, it has been held that the directors are not thereby authorized to repeal by-laws passed by the stockholders. 12 Unless directors are given independent power to adopt by-laws by statute or charter provisions, their by-laws may be repealed or amended at any duly assembled stockholders' meeting. 183. Common Law Liability of Directors The liabilities of directors fall naturally under two heads common law liabilities and liabilities imposed by statute. Under the common law the directors are personally liable for loss or damage resulting from ultra vires acts; 13 for any unlawful corporate act committed with their connivance, assent, or knowl- edge; for issuance of unpaid or partly paid stock as full-paid; for paying dividends, either negligently or wilfully, that impair the capital stock ; and for any other gross mismanagement. As trustees for the company, they are bound to give its affairs all requisite care and attention. If they do not, they are responsible for any resulting loss or damage. 14 They are not, however, responsible for the results of errors of judgment in their manage- ment of the ordinary business affairs of the corporation. 15 184. Statutory Liabilities of Directors In almost every state liabilities have been imposed upon directors by statute. Thus in New York a typical state directors may be held personally liable as follows: 11 Stevens v. Davison, 18 Gratt. (Va.) 819 (1868). "National Cash Reg. Co. v. Leland, 94 Fed. 502 (1899); McKinnon v. Morse, 177 Fed. 576 (1910); Hill v. Murphy, 212 Mass. I, 2, (1912). 14 3 Cook on Corp., } 703; Cassidy v. Uhlmann, 170 N. Y. 505 (1902); Hayes v. Pierson, 65 N. J. Eq. 353 (1903); Elliott v. Baker, 194 Mass. 518 (1907); Childs v. White, 158 App. Div. (N. Y.) i (1913). l Chick v. Fuller, 114 Fed. 22 (1902); United Zinc Cos. v. Harwood, 216 Mass. 474, 476 (1914); Holmes v. St. Joseph Lead Co., 168 App. Div. (N. Y.) 688 (1915). 152 CORPORATE LAW [Bk. I- 1. For declaring dividends except from surplus profits, or for dividing, withdrawing, or paying out any part of the capital except that authorized by law. 2. For making a loan of corporate money to any stockholder, or for discounting from corporate funds any note or evidence of debt for any stockholder, or for receiving the same for any instalment due on stock. 3. For making any certificate or report or public notice that is false in any material respect. 4. For making transfers of property to officers or stockhold- ers when the company is insolvent or threatened with insolvency, for the purpose of preferring or defrauding creditors. 5. In case of dissolution, as trustees for all corporate prop- erty that may come into their hands. In the majority of the states directors guilty of most of the enumerated offenses are not only personally liable, but are also criminally liable under the laws against fraud, larceny, and embezzlement. When any action is taken by the board in violation of law or which might involve its members in a liability, any dissenting director may always relieve himself from responsibility by proper procedure. In some states this procedure is prescribed by statute. Usually it involves the entry of his dissent or protest on the minutes of the particular meeting or, if such entry is refused, publication of the protest. It may be said generally that the law as to the liabilities and obligations of directors is much more satisfactory in theory than in practice, and that the best possible method of avoiding loss through wrongful or ill-judged acts of the directors is to confine the directorships only to men of known integrity and character. 185. Resignation of Directors A director is under no obligation to continue in the service of his corporation longer than he desires. Even though the Ch. 18] DIRECTORS 153 statutes or by-laws provide that he shall continue in office until the end of his term, he may resign at any time and thereby ter- minate his official position. 16 The effect of a resignation is governed by its terms. It may be tentative, requiring acceptance by the board before it is effective, or peremptory and effective as soon as delivered to the proper representative of the corporation. 17 The resignation should, for purposes of record and proof, be in writing, but an oral resignation properly presented to the board of directors and recorded in the minutes as so presented, is sufficient. It is obvious, however, that an oral resignation is objectionable on account of its difficulty of proof. A peremptory resignation may be made effective at a future date. A tentative resignation may fix a future date on which it will be effective if accepted. A peremptory resignation cannot be withdrawn after its formal presentation to the board, save with the consent of the board. A tentative resignation may be withdrawn at any time before its acceptance. 18 1 86. Removal of Directors The directors have no power to suspend or remove a fellow member of the board. The stockholders have a common law power to remove directors for adequate cause, but such removals are not frequent. The cause must be good and capable of proof, charges must be preferred, a meeting must be called, and the accused be given a hearing. The whole procedure is trouble- some, and it is usually preferable to await the expiration of an offending director's term rather than to attempt his forcible removal sooner. In some states, however, the statutes extend this common law power of removal, and wherever special provisions are permitted " 3 Clark & Marshall on Corp., I 667, and cases cited; Briggs v. Spaulding, 141 U. S. 132 (1891); Will of McNaughton. 138 Wis. 179, 208 (1909). 17 Manhattan Co. v. Kaldenberg. 165 N. Y. i (1900).' "See Book IV, Ch. XVIII, "Resignations" (forms). 154 CORPORATE LAW [Bk. I- in the charter the same end may be attained by proper charter provision. When thus given by the statutes or charter, the power of removal is- usually summary, i.e., an objectionable director may be removed by prescribed procedure usually by a two-thirds vote of the stock, but in a few states by a bare majority at once and with or without cause. Under these circumstances the removal of directors is more frequent. When the office of director has been usurped or is unlawfully held, and is claimed by a party who is not in possession, a writ of quo warranto will lie or an equitable action for possession may be instituted. 19 187. Vacancies on the Board . The stockholders alone have power to fill vacancies on the board, unless otherwise expressly provided by statute, charter, or by-laws. Such vacancies must therefore await the election of directors at the next annual meeting, or be filled by special election, unless the power of filling vacancies has been conferred upon the board. 20 It is advisable that the directors have this power, and in practice it is almost invariably given them. Vacancies on the board may be caused by the death, removal, resignation, or disability of a director, or the failure of a director- elect to accept his office. 21 The continued absence of a director from meetings is not itself sufficient to vacate his position. If it is desired that such continued absence shall have this effect, the by-laws should so provide, specifying the exact number of consecutive absences from regular meetings or from regular and special meetings necessary to create a vacancy. A board of directors may legally continue to act in spite of vacancies, provided enough remain to make up a quorum of the whole board. Less than a quorum of the board cannot fill vacancies unless expressly so empowered by charter or by-laws. 22 App, Ch. 1 8] DIRECTORS ! 55 * 1 88. Directors Holding Over "If the directors shall not be elected on the day designated in the by-laws, or by law, the corporation shall not for that reason be dissolved ; but every director shall continue to hold his office and discharge his duties until his successor has been elected." 22 This statement of the law taken from the New York statutes is also a statement of the common law, existing in practically every state. 23 A similar provision also usually appears in the by-laws. The powers of directors who continue in office because of a failure to elect their successors are trie same in every respect as before their term of office expired. They are directors both de jure (by right) and de facto (in fact), and their acts are valid. 24 The smaller corporations relying upon this condition some- times omit the annual meeting with its election of directors for years, thereby avoiding the formalities of the annual meeting. In such case the old board holds over indefinitely and, duly empowered thereto by charter or by-laws, fills by vote of its own members any vacancies that may occur. So long as the stock- holders do not protest, the practice is not legally objectionable. In New York the omission of the election of directors for eight years has been upheld. 25 189. Directors Dealing with Corporation The subject of directors' dealings with their corporations is too extensive for full treatment here. A director occupies a fiduciary relation to his corporation and should as far as possible avoid any position in which his personal interest is adverse to that of the corporation. He may, however, speaking generally, make any contract with his corporation that is fair and to its interest. His contract is therefore not void but merely voidable, = Gen. Corp. Law, N. Y.. 5 28. State v. Bonnell, 35 Ohio St. 10 (1878); Appleton v. Am. Malting Co., 65 N. J. Eq. 375 (1903). 24 3 Cook on Corp., 5 713; Kent Co.. etc., Society y. Houseman, 81 Mich. 609 (1890) Geneva Mineral Springs v. Coursey, 45 App. Div. (N. Y.) 268, 275 (1899). 156 CORPORATE LAW [Bk. I- and if no stockholder objects will stand. 26 Also cases have arisen where a contract between a director and his corporation has been ratified by a majority of stockholders at a duly called meeting, and the courts have sustained the contract. 27 Also, if all the stock is owned by the directors and there are no creditors, a director may contract with his corporation at pleasure. 28 In all cases where a director is personally interested in any particular contract or other matter to be acted upon by the board, he should withdraw from the room while the vote is being taken and his absence should be noted on the minutes. To-be valid the action must be taken by a legal quorum exclusive of the interested party. 29 The United States Steel Corporation, in its by-laws provides for such a situation as follows: Contracts. Inasmuch as the Directors of this Company are men of large and diversified business interests, and are likely to be connected with other corporations with which from time to time this Company must have business dealings, no contract or other transaction between this Company and any other corporation shall be affected by the fact that directors of this Company are interested in, or are directors or officers of, such other corporation, if, at the meeting of the board, or of the committee of this Company, mak- ing, authorizing or confirming such contract or transaction, there shall be present a quorum of directors not so interested; and any director individually may be a party to, or may be interested in, any contract or transaction of this Company, provided that such contract or transaction shall be approved or be ratified by the affirmative vote of at least ten directors not so interested. Tort Payne Rolling Mill v. Hill, 174 Mass. 224 (1899); Welch v. Bank, 122 N. Y. 17? (1890); Cont. Ins. Co. v. N. Y., etc., R. R. Co., 187 N. Y. 225 (1907). 17 Nye v. Storer, 168 Mass. 53 (1897); Gamble v. Queens Co. Water Co., 123 N. Y. 91 (1890). 28 McCracken v. Robison, 57 Fed. 375 (1893); Barr v. R. R. Co., 125 N. Y. 263 (1891). M Curtin v. Salmon, etc., Co., 130 Cal. 345 (1900); Steele v. Gold, etc., Co., 95 Pac. (Colo.) 349 (1008); Schaffhauser v. Brewing Co., 218 Pa. St. 298 (1907). CHAPTER XIX OFFICERS 190. General The term "officers" is here applied to those permanent agents of the corporation appointed or elected usually by the board of directors as the direct representatives of the board and of the corporation. The directors themselves are at times, and with legal correctness, styled "officers," but to avoid confusion the term is as a rule employed in the present volume to designate those officials subordinate to the board. 1 The necessary officers of a corporation, sometimes termed the "executive officers," are the president, secretary, and treasurer. One or more vice-presidents are usual. In addition to these, other officers or agents are frequently appointed, as managing directors, general managers or superintendents, counsel, auditors, and special agents for particular purposes. 191. Appointment of Officers The stockholders have the original right to elect or appoint officers of their corporation, and in the absence of preventing statutes this power may be reserved to them. In practice, how- ever, by express provision of the statutes, charter, or by-laws the power of appointing officers is almost invariably vested in the board of directors. The election of one person to two corporate offices is common, and is usually authorized by charter or by-law provision. If otherwise, the board still has power to combine any two or more official positions in one person if the duties of the combined positions do not conflict. 2 1 See Ch. XXXIII, "By-LawsOfficers." 2 People v. Green, 58 N. Y. 295-304 (1874); 3 Cook on Corp., 5 712. 157 158 CORPORATE LAW . [Bk. I- The term for which corporate officials are elected is usually prescribed by proper charter or by-law provision, and seldom exceeds one year. As a matter of business policy such term should not be longer than that of the directors by whom the officials are elected. That is, if the directors are elected annually, the officers also should be elected annually so that each new board may appoint its own agents. The appointment of managers, experts, or other specially skilled employees is, however, of a different nature. These are not so directly agents of the board, and contracts for their serv- ices extending over a term of years are frequently advantageous or even necessary to the corporation. Such contracts are entirely within the power of the board without special charter or by-law authorization. Unless they resign or are removed in some manner, the cor- porate officials hold over after the expiration of their elective term, until they are relieved by properly elected or appointed successors. 3 This is frequently a statute, charter, or by-law provision, but, if otherwise, is a matter of common law. These officials have every power that they possessed before the expira- tion of their elective terms. As the board elects and appoints officers, it has also the power to fill vacancies among them without specific authorization. 192. Qualifications of Officers The officers are the agents of the board of directors and of the corporation. Hence anyone who may act as an agent is capable of acting as a corporate official, and in the absence of prohibition, a married woman, a minor, an alien, or one of its own directors may be legally elected as an officer of the corporation. Membership in the board is, as a rule, a necessary qualifica- tion for the president and vice-president of a corporation. They are almost invariably the presiding officers of the board, and when 1 Mining Co. v. Abraham, 26 Ore. 282 (1894); Agricultural Soc. v. Houseman, 81 Mich. 609 (1890); Quitman Oil Co. v. Peacock, 81 S. E. (Ga.) 908 (1914). Ch. 19] OFFICERS 159 this is the case the election of a president or vice-president not a member of that body might lead to difficult situations. 193. Powers and Duties of Officers The mere fact of election to office does not necessarily in itself confer any power or duties upon the officials of a corporation. 4 Custom or usage may have attached certain powers and duties to certain official positions, but the corporation may disregard this and vary the powers and duties of the different officers as seems to it best. In general it may be said of corporate officials that, as agents of the corporation, they are governed by the general law of agency. Accordingly a corporate official has only those powers which are conferred upon him or are incidental to the exercise of these powers. The different sources from which the powers of corporate officials are derived are, given in rank of their authority, (i) the statutes of the state, (2) the charter, (3) the by-laws, (4) resolu- tions of directors, and (5) usage. Statutory provisions affecting corporate officials are few. The charter likewise but seldom contains provisions affecting the officers of the corporation, though occasionally such pro- visions are inserted therein for the sake of permanence. The by-laws, however, usually prescribe the official powers and duties with fulness; and the directors, subject to the provisions of the higher authorities referred to, confer such other proper official powers and prescribe such other official duties as they see fit. Beyond all these, it will usually be found that the officers transact certain routine business 5 and perform certain duties as a matter of custom, and their acts are valid and binding upon the corporation, even though not specifically authorized. 6 4 R. R. Co. v. Bayne, n Hun (N. Y.) 166; affd., 75 N. Y. I (1877); Cushman v. Cleveland, etc., Co., 84 N. E. (Ind.) 759 (1908); Emmet v. Northern Bank, 173 App. Div. (N. Y.) 840 (1916); Marqusee v. Ins. Co., 211 Fed. 903 (1914). * Fitzgerald, etc., Co. v. Fitzgerald, 137 U. S. 98 (1890). ' Ins. Co. v. McCain, 96 U. S. 84 (1877); Story on Agency, 55 126, 127. 160 CORPORATE LAW [Bk. I- Also it may be stated -generally that, whenever the directors permit an officer to exercise apparent authority in the corporate affairs or transactions, the corporation is bound thereby as to third persons as fully as if such officer had been duly authorized. 7 Beyond this, corporate officers not infrequently act clearly without the bounds* of their authority, relying upon ratification of their acts by the board of directors later. If so ratified, the corporation is bound and the officials are absolved from all responsibility for their ultra vires acts. 8 If, however, the official action is not ratified, the corporation is not bound and the officers are personally liable for their acts. 9 The validity of an officer's acts depends entirely upon his authority and not on the place in which the authority is exer- cised. 10 Therefore, when in the proper discharge of his duties, his acts are as effective in one place as another and equally binding upon the corporation. 194. Delegation of Officers' Authority The board may temporarily delegate the powers of an official to another person, provided such delegation is reasonable and only for such length of time as may be actually necessary to conserve the interests of the corporation. An officer cannot delegate his powers to another officer in any material matter, even temporarily, unless specially authorized thereto by the by- laws or by action of the board. 11 195. Liabilities of Officers An officer contracting for his corporation within the limits of his authority is merely a corporate agent, and if not guilty of > New York & New Haven R. R. Co. v. Schuyler, 34 N. Y. 30 (1865); 3 Clark & Marshall on Corp., $ 708; Louchheim v. Bldg. Assn., 211 Pa. St. 499 (1905); Rankin v. Tygard, 198 Fed. 795 (1912). 8 Rolling Mill v. R. R., 120 U. S. 256 (1886); Nims v. Boys' School, 160 Mass. 177(1893); Topolewski v. Plankinton Packing Co., 143 Wis. 52 (1910). Malone v. Pierce', 231 Pa. St. 534 (1911); Falls City Lumber Co. v. Watkins, 53 Ore. 212 (1909). 10 Hastings v. Ins. Co., 138 N. Y. 473 (1893). 11 Caldwell v. Life Assn.. 53 App. Div. (N. Y.) 245 (1900). As to when corporation will be bound see Emerson v. Hat Co., 12 Mass. 237 (1815); also Luttrell v. Martin, 112 N. C. 593 (1893). Ch. 19] OFFICERS 161 fraud or deceit, does not bind himself and cannot be held per- sonally liable in any way. If, however, he exceeds his authority he renders himself personally liable, 12 unless the corporation later ratifies the unauthorized action, 13 in which case he is released. Officers are bound to use ordinary care and diligence in the conduct of the corporate business and are therefore liable for any losses caused by their neglect, mismanagement, or wrong- doing in the discharge of their official duties, 14 though not for an error of judgment. 15 An officer is also personally liable for any wrong he does on behalf of his corporation, such as sending out false and deceptive reports, statements, prospectus, etc., even though the corpora- tion is also liable. 16 In many states statutes exist prescribing penalties for various misdeeds of corporate officials. Thus in New York neglect to make proper entries in the stock book, or to exhibit this book on request to those entitled to its inspection, involves a penalty of $50 and of resulting damages; rendering a false report in- volves liability for all resulting damages; loaning corporate funds to a stockholder or allowing him to withdraw his investment in any way renders officers and directors personally liable for all debts of the corporation until the amount is returned; while the penalty for falsifying accounts or erasing or destroying the cor- porate records is the same as that for forgery, -> gnibnoBo. afc /ttiw tojnJnoo 196. De Facto Officers A de facto officer is one actually in possession of an office and exercising its powers and duties by virtue of some other authority or right than that of a regular, unquestioned election or appoint- 12 See citations in footnote 9. See citations in footnote 8. 14 3 Cook on Corp., { 702, and cases there cited; McEwen v. Kelly, 140 Ga. 720 (1913); United Zinc Cos. v. Harwood, 216 Mass. 474 (1914); Childs v. White, 158 App. Div. (N. Y.) i (1913). " Briggs v. Spaulding, 141 U. S. 132 (1890); People v. Equit., etc.. Society, 124 App. Div. (N. Y.) 714 (1908). Cowley v. Smyth, 46 N. J. L. 380 (1884); Morgan v. Skiddy, 62 N. Y. 319 (1875). 162 CORPORATE LAW [Bk. I- ment. He must be "distinguished on the one hand from a mere usurper of an office, and on the other hand from an officer de jure," 11 i.e., one holding his position by legal right. It not in- frequently happens that the results of an election are disputed or that an election is not held. In the first case if the officers claiming election enter upon their official duties, or in the second case if the old officers continue in office, the acting officials are de facto officers, and, until ousted or superseded, their official acts are legal and binding upon the corporation. Speaking generally it may be said that anyone connected with a corporation who is publicly allowed to act as its officer or agent is a de facto officer. Persons dealing with the corporation cannot usually investigate and ascertain whether those who purport to represent it are legally appointed. The law therefore holds that the acts of these de facto officers are binding on the company even though they have no legal right to the position they pretend to hold. 197. Removal of Officers When an officer is elected for a definite term and accepts the office, a contract has been made for that term, and unless power has been given the board by express provision of statutes, charter, or by-laws to remove the corporate officers at pleasure, the in- cumbent can be legally removed only for cause. 18 If a removal is to be made, the cause must be such as will justify breaking the contract with the offending official, charges must be brought against him, and he must be allowed an opportunity to defend himself. 19 If removed without cause, his official status ceases but the corporation is liable to him for breach of contract. 20 In some few states the statutes give the directors power to remove officers at pleasure. Elsewhere it may be given them "Waterman v. Chicago, etc., R. R. Co.. 139 111. 658-665 (1892); Merchants' Bank v. Citizens' Gas Light Co., i$9'Mass. 505 (1893)- 18 State v. Kuehn, 34 Wis. 229 (1874). 18 State v. Adams, 44 Mo. 570, 585 (i869);-State v. Kuehn, 34 Wis. 299 (1874). 2/n re Griffing Iron Co., 63 N. J. L. 168 (1899); Brindley v. Walker, 70 Atl. Rep. (Pa.) 794 (1908). Ch. 19] OFFICERS 163 by charter or by-law provision. 21 Such provisions are usually desirable, as the board is responsible for the proper conduct of the corporate business and should have power to remove an objectionable official without the necessity of a formal trial. When by-laws are adopted giving the directors power to remove officers without cause, they do not authorize the removal of officers already elected, but are effective as to officers elected thereafter. 198. Resignation of an Officer Under the usual conditions of election, a corporate officer may resign at will, 22 unless he has entered into some distinct agree- ment to serve the corporation for a fixed period. His resignation should as a rule be in writing, be phrased to meet the exact end in view, and be delivered to the secretary; 23 though an oral resignation in open meeting is sufficient, especially if followed by acceptance by the board. 24 It has been held that all the cor- porate officers cannot resign at once for the purpose of throwing the corporation into the hands of a receiver, 25 or to free them- selves from their obligations in regard to the custody of the cor- porate property. 26 21 State v. Adams, 44 Mo. 570, 585 (1869); Darrah v. Ice & Storage Co., 50 W. Va. 417 (1901); Douglass v. Merchants' Ins. Co., 118 N. Y. 484 (1890). a Yorkville Bank v. Zeltner B. Co., 80 App. Div. (N. Y.) 578 (1903); Van Amburgh v. Baker, 81 N. Y. 46 (1880). See Book IV, Ch. XVIII, "Resignations" (forms). 23 Manhattan Co. v. Kaldenberg, 165 N. Y. i (1900); Noble v. Euler, 20 App. Div. (N. Y.) 548 (1897). 24 Briggs v. Spaulding, 141 U. S. 132-152 (1891); Fearing v. Glenn, 73 Fed, 116 (1896). "Zeltner v. Brewing Co., 174 N. Y. 247 (1903). * Yorkville Bank v. Zeltner B. Co., 80 App. Div. (N. Y.) 578 (1903). Part V The Charter CHAPTER XX CHARTER GENERAL CONSIDERATIONS 199. Nature of Charter The foundation of the corporation is a formal written grant or authorization from the state. This instrument, originally known as the "charter," is now usually designated by the statute laws of the various states as the "certificate of incorporation" or the "articles of association." 1 From a legal standpoint there is no distinction between these different names. As a matter of convenience the term "charter" is generally employed in the present volume. The charter may be granted by a particular state, or by the general government as in the case of national banks and certain other corporate organizations. It is a recog- nized principle that all statutory laws of the* state of incorpora- tion governing or regulating corporations become a part of the charter. 2 Formerly every charter was created, or authorized, by a separate legislative act. Charters termed "special charters" are still granted in some states by act of legislature for special cor- porations, but the greater number of corporations are organized under state laws of general application. 3 All corporations have certain common law powers, such as the right to sue and be sued under the corporate name, the right 1 Book IV, Ch. I, "Charter Forms." 'Ellerman v. Railway Co., 49 N. J. Eq. 217 (1891); Bixler v. Summerfield, 195 111. 147 (1902); Westport Stone Co. v. Thomas, 175 Ind. 319 (1910). See f 205. 165 166 CORPORATE LAW [Bk. I- to contract and to use the corporate seal. In addition they have any general powers granted by the statutes and the special rights granted by their respective charters, such as the use of the particular name, the right to carry on the special business and to have a certain capital stock. They also have such incidental powers as are necessary to render these express powers effective. If any further corporate powers allowable under the laws of the state of incorporation are desired, they must be secured by proper amendment of the charter. Their exercise otherwise is ultra vires, i.e., beyond the powers of the company. As the charter is usually a very formal instrument, and the procedure for its amendment is also formal and usually trouble- some, it is important that all desired purposes and powers should be stated with clearness and fulness in the original charter application. The powers and privileges conferred upon a corporation by its charter are only such as are allowable under the laws of the state of incorporation. Ordinarily any provisions of a different tenor would be refused or stricken out of the charter application by the state officials. Occasionally it happens, however, through official ignorance, inadvertence, or indifference, that powers and privileges illegal or not permissible are passed and apparently granted by the charter of a corporation. Such appearance is deceptive. The corporation is empowered by its charter just so far as that instrument is in accord with the law of the state and no further. The charter is not and cannot be superior to the law, and is absolutely ineffective just so far as it goes beyond. 4 It must be noted that the ordinary business corporation does not. in any but a technical sense of the word receive a franchise, as the granting of the charter does not give it any powers that will not be freely given to any other incorporation upon like application, s 4 People v. Chicago Gas Trust Co., 130 111. 268 (1889). 6 2 Morawetz on Corp., 923. Ch. 20] CHARTER GENERAL CONSIDERATIONS 167 200. Classification Charters are divided into two important classes by the gen- eral division of corporations into stock and non-stock or member- ship corporations. Charters for membership corporations are not treated specifically in the present volume. Beyond this general division, stock corporations and the charters creating them may be divided into three important classes as follows: 1. Business corporations, organized to conduct an ordinary mining, mercantile, manufacturing, or other private business. 2. Public utility corporations, organized to undertake some public function, such as the supply of heat, light, power, or water, or the construction or operation of a railway, a telephone or telegraph system. 3. Financial corporations, as banks, trust companies, building associations, and insurance companies. The corporations of each of these classes are created by char- ters differing from those of the other classes in form and terms, though all conform to the general principles governing charters. The characteristic features of each of these classes of corporations are given in the following sections 201. (i) Business Corporations This term is used to designate corporations organized to conduct those various forms of private business not subject to special regulations and restrictions in the interest of the public. All corporations for mining, manufacturing, and mer- cantile pursuits are included under this head. Business corporations are, as a rule, chartered in each state under general, uniform laws and forms, have no special privi- leges, and when incorporated are allowed to pursue their cor- porate ends almost as freely and as simply as would a private individual or firm under the same circumstances. The majority 1 68 CORPORATE LAW [Bk. I- of existing corporations belong to this class and the great mass of corporate law and decisions applies to them primarily. For the other classes of stock corporations there are special laws, special limitations, and in some cases special privileges. 202. (2) Public Utility Corporations Public utility or public service corporations are those organ- ized for the purpose of securing and operating under some franchise of a public nature, which confers upon such corpora- tions rights or privileges which other citizens and private cor- porations do not enjoy. Usually these franchises carry with them certain rights of way, or condemnation powers to secure such rights granted by the state under its power of eminent domain. An ordinary private corporation enjoys no exclusive franchise, and any other body of citizens may incorporate for the same purposes. A company organized to operate a public utility must, however, have special rights and powers affecting the public welfare or convenience, and usually another similar cor- poration would not be granted these identical rights and powers while the former corporation was in active existence. For instance, a gas company must have the right to tear up streets in order to lay and repair its pipes. The ordinary citizen or corporation has no such right. If such right were granted to one company, the same right in the same territory would not properly be granted to another company. Should such double concession be made, it would be but a short time until, in obedience to well- known economic laws, the two competing companies would combine. This peculiarity is true of all classes of public utility corpora- tions. They enjoy franchises that cannot be granted indis- criminately and that tend inevitably to monopoly. They enjoy these special privileges for the purpose of supplying certain public needs that must be supplied uniformly. They cannot be given the liberty to make prices and conditions that obtain in the con- Ch. 20] CHARTER GENERAL CONSIDERATIONS 169 duct of a private corporation. Hence, the laws under which they receive charters should guard against the indiscriminate bestowal of such rights and should carefully regulate charges and methods. In many states the charters of public utility corporations are granted only by special acts of legislation; in others, commissions pass upon such applications and decide whether the public wel- fare requires the issuance of the desired charter; while in other states such corporations are chartered under the provisions of general laws. 203. (3) Financial Corporations Experience has shown that it is unsafe to allow irresponsible parties to incorporate and conduct banks, trust companies, savings institutions, and similar associations dealing with the funds of others. Hence institutions of this sort are now so hedged about with restrictions and limitations that, in a measure at least, their conduct is confined to reputable and responsible people. Their safety is also partially assured by stringent rules as to the payment of stock subscriptions in cash before business is commenced, and as to the liability of their stockholders there- after. In national banks and in many state banks a stock- holder's liability is equal to the face value of his stock, thus nominally placing $200 behind each $100 of stock as security for the deposits and other liabilities of such institutions. In many cases this extra $100 is paid in and used as surplus. Usually charter applications for financial corporations must be approved by some department or official of the state; and after incorporation their affairs are subject to the inspection and supervision of the state officials, and their officers are required to make regular reports of their business and financial condition. National banks are under the jurisdiction of the United States laws and are not subject to this supervision and regulation from the authorities of the state in which they operate. Speaking generally, both public utility corporations and financial institutions chartered by the state are subject to the 170 CORPORATE LAW [Bk. I- usual statute law regulating stock corporations, and in addition to such special legislation as may affect them. If doing business in other states, they would be governed by the local regulations affecting such foreign corporations. 204. Charter Details When a corporation is to be organized, all the important features which are peculiar to the new corporation and which are not secured to it by the common law or are necessarily incident to incorporation, should appear in its charter. These are usually the name, purposes, duration, location, capitalization and the details thereof; also in some states the number of directors and the names of those who are to act for the first year, and any desired special provisions that can be made a permanent part of the corporate organization under the laws of the state of incor- poration. Temporary or less important details may be left for by-law or other regulation, but all matters of permanence or importance should appear in the charter as far as possible. The statutes usually require the main features outlined above to appear in the charter. 6 In New York, New Jersey, arid some other states, special provisions may be inserted in the charter for the regulation and conduct of the corporate business and affairs and for any proper limitations on the powers of its officials. This leaves wide scope for the insertion of such provisions and many varying arrange- ments result from this freedom. 205. Application for Charter Special charters are prohibited by constitutional provision in a number of states. Where not prohibited they are secured by application to the legislature. In such case the charter ap- plication is put in the form of an act declaring that certain named parties and their successors are a body corporate for the purposes enumerated. This act, if passed by the legislature, becomes See Book IV, Ch. I. "Charter Forms." Ch. 20] CHARTER GENERAL CONSIDERATIONS 171 the charter of the company and is its sole authority for existence and operation. The granting of special charters is a source of grave abuses, and in many states, as already said, is prohibited by constitu- tional provisions. In other states, however, as in New York, such charters are still granted, and charters may be secured either under the general corporation laws or, where sufficient influence exists, by direct appeal to the legislature. In all the states general laws have been passed prescribing the method whereby charters may be secured. These laws are modified by special additional requirements in the case of financial and public utility corporations. Under the provisions of such general laws, when due and proper application is made with payment of the proper fees, the secretary of state must issue a charter in accordance with the terms of the application, or if actual issuance of the charter is not required, the official acceptance and filing of the application, ipso facto, authorizes the parties to organize as a corporation. This is the usual procedure under which the great majority of modern business corporations come into existence. It is a matter of right, not of favor, and is available equally for all qualified persons who choose to comply with the necessary formalities and pay the required fees. CHAPTER XXI CHARTER INCORPORATORS 206. Who May Incorporate Corporations are creatures of the law. They derive their right to existence either from direct legislative enactment or from the general laws under which they are formed. Therefore, only those may incorporate who are expressly authorized thereto by these special acts or under these general laws. In each state the statutes must be consulted in order to ascertain definitely just who may participate in any proposed incorporation. Usually the statutes authorizing incorporations employ the term "persons" or "natural persons" in prescribing who may incorporate. This wording excludes a firm, a corporation, or anyone acting in a representative capacity. Any of these might hold stock in the corporation when organized, but could not legally act as an incorporator. 1 As the charter is in effect a contract, a person unable to con- tract cannot properly act as an incorporator. This is a matter of common law and excludes minors, persons of unsound mind, and others similarly incompetent to contract. Under the old common law it would also exclude married women, but this disability has been generally removed and married women fre- quently act as incorporators. In some states one or more of the incorporators must be citizens of the state of incorporation. Unless this is expressly prescribed, any person otherwise competent can act, whether a citizen of the state or not. Incorporators need not even be cit- izens of the United States unless expressly required by the stat- 1 Schwab v. Potter, 194 N. Y. 409, 416 (1909); Converse v. Emerson, Talcott & Co., 148 111. App. 604 (1909). 172 Ch. 21] CHARTER INCORPORATORS 173 utes. In New York, at least one of the incorporators must be a resident of the state, and two-thirds of the total number must be citizens of the United States. In New Jersey none of the incorporators need be citizens either of the state or of the United States. It must be borne in mind that each state has the entire right to impose any qualifications on incorporators that its legis- lators deem desirable, and that there is no appeal from such statutory requirements. Usually, however, the matter is not of great importance, since, if any of the proposed incorporators are barred by statute requirements, a substitute may be ap- pointed who is qualified, and who will act up to such point as is necessary or desirable and then transfer his subscription and all his rights to the party for whom he has been acting. This utilization of "dummy" incorporators for the preliminary organization, is a common procedure. 2 ymftt'ub" od '{BnT'^rli to .nob 207. Number of Incorporators In every state the minimum number of incorporators is prescribed by statute. In most states this minimum is three, though in a few states five are required. No maximum number is designated in any state, this feature being a matter of no im- portance from the standpoint of the state. As a general rule it is advisable to incorporate with the min- imum number of incorporators permitted by the statutes. Usually each incorporator must sign and acknowledge the charter application, and must either sanction or participate in the first meeting, and these proceedings are much facilitated by a small number of incorporators. At times different interests must be represented in an incorporation and the subsequent organiza- tion, and a considerable number of incorporators is therefore unavoidable; but without some such reason the minimum number is to be preferred. See | 210. 174 CORPORATE LAW [Bk. I- 208. Functions of Incorporators The incorporators furnish the nucleus about which the new corporation is formed, and are the active agents in bringing it into existence. They are essential participants in the formalities incident ^to the creation of the corporation. They must usually sign and acknowledge the charter and are generally required to be subscribers to the stock of the corporation. They call and conduct the first meeting. The organization of the corporation is usually entirely in their hands, though in case they are not the real parties in interest, i.e., are "dummy" incorporators acting for others, the organization and first proceedings will be pre- scribed for them in advance. It will be seen that the only necessary function of the incor- porators is to figure in certain formalities incident to the forma- tion of the new corporation. They may be the real parties in interest who will remain with and own stock in the new corpora- tion, or they may be "dummy" incorporators, called in merely as a matter of convenience or for more cogent reasons, without interest in the corporation beyond their perfunctory subscription for one or more qualifying shares an interest that is usually assigned to the real parties in interest so soon as the corporation is once organized and ready to begin its operations. 209. Incorporators as Stockholders It is usual for incorporators to be subscribers for one or more shares of stock in the proposed corporation. In most of the states, such subscription is either required, or it is assumed that such subscription will be made. If not either directly or infer- entially required by the statutes, such subscription is not essential. When an incorporation is effected with incorporators who do not desire, or are not desired, to remain as permanent stock- holders, it is usual, after the organization has been completed, for the incorporators to assign their subscription rights or their stock to those parties who are to be the real owners of the cor- Ch. 21] CHARTER INCORPORATORS 175 poration. These latter assume the obligations of the incorpora- tors on the assigned subscriptions of stock, and if the transaction is acquiesced in by the corporation, it is then legally complete and the original incorporators are in most states discharged from any subscription obligations either to the corporation or to cor- porate creditors. 3 rfrwv Mhwq s'i;*?/r*sa$*ioqioDni s-nrfT .vr,w eiiti ni boJ:Tb 210. Dummy Incorporators As has been stated, any competent person may join in an incorporation without any material or permanent interest in the matter, and such non-interested or "dummy" incorporators are frequently employed. Sometimes this is done where the real parties in interest do not deem it advisable to appear as incor- porators; sometimes of necessity because of the absence of the principals; and sometimes purely as a matter of convenience, the real parties concerned being disinclined or too busy to under- take themselves the technical duties of incorporators. In such cases the dummy incorporators execute the charter and organize the corporation, usually subscribing for the smallest number of shares that will satisfy the statute requirements, and carrying the organization to such point as the real parties in interest or their attorneys indicate. The "dummies" then assign their subscription rights or stock, resign any official posi- tions they may hold in the new corporation, and step out. Such an incorporation, if properly conducted, is entirely legal, and the method is that pursued in the formation of almost all the larger corporations and combinations. The proceedings are, as a matter of course, supervised and ordinarily conducted by the attorneys of the parties really interested, these attorneys dictating all that is done and seeing that the interests of their clients are properly conserved. The proceeding is carried as far as the conditions render advisable before the dummy incor- porators make way for their principals. Usually they fully 1 1 Cook on Corp., } 255, and cases cited. 176 CORPORATE LAW .Bk. I- complete the organization of the corporation, electing themselves directors and officials, or perhaps electing to the official positions the parties who are to be permanent incumbents. Meanwhile they usually take action of the greatest moment to the future of the new organization. The organization of the United States Steel Corporation was effected in this way. Three incorporators were provided, each of whom subscribed for ten shares of stock out of a total capitali- zation of but $3,000. As soon as the organization of the new corporation was completed, the incorporators were retired, the real parties in interest came in, and the capitalization was in- creased to $1,100,000,000. In such cases the incorporators are usually the junior counsel and clerks in the offices of the attorneys having the incorpora- tion in charge. As stated, if the incorporators are properly qualified and the proceedings are conducted in accordance with the statutory requirements, there is no question as to the legality of the use of dummy incorporators, even where properties of large value are taken over for the corporation by these irresponsible parties. CHAPTER XXII CHARTER THE CORPORATE NAME 211. Selection of Name The selection of the corporate name is frequently a matter of considerable importance, though usually governed by business considerations rather than legal rules. As a matter of both taste and business, a name should be selected that is distinctive, not too long, and, if possible, expressive of the business to be done by the corporation. The selected name should not be fraudulent or misleading, nor should it infringe on the rights of others. 1 In the incorporation of a partnership, the general usage is to retain the partnership name with only such changes as will indicate the corporate organization. 2 In most states great latitude is allowed in the selection of the corporate name, the prohibition against conflicting names being practically the only restriction. If not required by statute, the use of the prefix "The" is to be avoided as unnecessarily lengthening the name and producing a peculiarly awkward effect in legal instruments when the name is used following the word "said," as is frequently the case. Hackneyed names such as "Standard," "Union," "National," etc., as well as much-used geographical names, are to be avoided, both as a matter of taste and business. No trade-name rights can ordinarily be secured in such well-worn designations, though in some cases the first user of a geographical name will be protected in the right where it has been used over a period of years. 3 '/ ">rn '.'.>!.' 1 i Machen on Corp., { 450; Von Thodorvich v. Beneficial Assn., 154 Fed. 911 (1907). 1 Columbia Mill Co. v. Alcorn, 150 U. S. 460 (1893); Corning Glass Works v. Corning Cut Glass Works, 197 N. Y. 173 (1900). 5 Kayser & Co. v. Italian Silk Underwear Co., 160 App. Div. (N. Y.) 607 (1914); British- American Tobacco Co. v. British-American Cigar Stores Co., 211 Fed. 933 (1914). 177 178 CORPORATE LAW [Bk. I- 212. How Secured The name of the proposed corporation must be set forth specifically in its charter application. This name, so soon as the application is allowed, becomes the name and property of the new corporation. In the state of incorporation the right to such name is exclusive. If the desired name were the same as that of some other domestic corporation or foreign corporation licensed to do business within the state, or so nearly the same as to cause confusion, that fact alone would be ground for the rejection of the charter application. But few statutory restrictions exist in regard to the cor- porate name. The prohibition against the adoption of a name similar to that of a corporation already doing business under the state laws is the most important. In some states the prefix "The" must be used to introduce the corporate appellation; in some states "Corporation," "Company," "Association," or some other word expressing the idea of corporate association must be used in the corporate name. In some few states the word "Incorporated" or "Limited" must follow the corporate designation. 4 In New York every corporation must use such word or words, abbreviations, affix, or prefix as will distinguish it from a natural person, firm, or copartnership. In 1912 a lower court refused to allow an existing corporation to change its name to one ending in "Company." Since then the state authorities refuse to charter any corporations with a name terminating in "Company," unless followed by "Inc." In most of the states insurance and moneyed corporations, and in many states co-operative corporations, must be organized under special statutes, and in these states the statutes usually provide that the corporation not organized under the special laws shall not use the words "Trust," "Bank," "Insurance," "Co-operative," and like words in their corporate titles. 4 i Machen on Corp., 449, and notes. Ch. 22] CHARTER CORPORATE NAME 179 The state authorities would have no right to refuse a charter application on the ground that some foreign corporation not licensed by the state is using the selected name. In such event the charter application, if no other objection existed, must be allowed, leaving the right to use the name to be settled between the two corporations. 213. Right to Corporate Name One important object of incorporation is to secure per- manence, and the corporate name is an almost essential element of this desired commercial continuity. Once established, the name is the embodiment of the good-will of the enterprise and has a value in accordance. If the corporation is properly managed and is successful, this value is frequently very con- siderable. In some instances it is the chief asset of a prosperous business. The corporation's right to its name is the same as to any other trade-mark or trade-name possessed by it, and is generally more easily established. If the name is used by other parties without authority, such use may be stopped by injunction, and if damage can be shown, an action will lie against the offending parties. 5 The same rule applies whether the infringement is by another corporation or by the adoption of a trade-name by an individual or partnership. 6 A corporation cannot take the name of an existing copartnership, where this would result in injury to the partnership. If it does take such a name it may be enjoined. 7 As has been stated, ' there is usually no statute restriction against the adoption of the name of a foreign corporation by a domestic corporation if such foreign corporation has not been licensed to operate in the state. The allowance of such name would not, however, give the new corporation an un- * Higgins Co. v. Higginn Soap Co., 144 N. Y. 462 (1895); Corning Glass Works v. Corning Cut Glass Co., 197 N. Y. 173 (1910); Salvation Army v. Am. Salvation Army, 135 A. D. (N. Y.) 268 (1909). German-Amer. Button Co. v. Heymsfeld, 170 App. Div. (N. Y.) 416 (1915). Pettes v. Am. W. C. Co., 89 A. D. (N. Y.) 345 (1903). l8o CORPORATE LAW [Bk. I- questioned right to its use. If the older corporation could show that it had a trade right in the name, and that the use of the name by the new corporation would.be injurious to this right, and would permit it to compete unfairly, the new corporation might be enjoined from the use of such name, and, if the injunc- tion should be sustained, would be compelled either to secure a new name by due and formal procedure or to discontinue its operations. 8 In New York a foreign corporation will be refused ad- mittance to the state on the ground that another corporation is doing business under the same or a similar name ; but in North Carolina, under a ruling of the Attorney-General, foreign cor- porations will not be excluded from the state because another corporation is already doing business under the same name. 9 Where confusion in delivery of mail results from similarity of corporate names, the courts favor the corporation that first lawfully used the name. 10 214. Changing the Corporate Name Occasionally it becomes necessary or expedient to change the corporate name. It may be that the use of the name first adopted is prevented by injunction, or new interests may have come in, that as a matter of business policy must be represented in the corporate name, or possibly the corporation has been unsuccessful or has achieved a bad reputation, and the adoption of a new name is thought desirable. In any such case the name may usually be changed but only with the permission and sanc- tion of the state. In many states the change of name must be secured by an amendment to the charter, which is a more or less troublesome operation according to the statutory requirements of the particular state. Other more or less troublesome pro- 8 Benevolent Order of Elks v. Improved Benevolent Order, etc., 205 N. Y. 459 (1912); Hoevel Sandblast Machine Co. v. Hoevel S. M. Co. of N. Y., Inc., 167 App. Div. (N. Y.) 5*8 (1915)- Atty.-Gen.'s opinion. Biennial Report, 1913-14, p. 92. Central Trust Co. v. Central Trust Co. of H1...I49 Fed. 789 (1906). Ch/2 2 ] CHARTER CORPORATE NAME 181 ceedings obtain in different states, as in New York where formerly the only method of changing the corporate name was by formal court proceedings. The formalities incident to a change of corporate name are so great that in some cases it is simpler and no more ex- pensive to organize a new corporation and transfer to it the assets of the existing corporation, than to take the time and trouble incident to a change of name by the regular procedure. In such a case, from the legal standpoint the old company has ceased to exist and a new company has come into existence. A mere change of name, on the other hand, does not affect the identity of the corporation. 11 11 Allen v. M. E. Church, 127 Iowa 96 (1905); N. B. Lumber Co. v. Sims & White, 157 Ala. 595 (1908); Carlon v. City Savings Bank, 82 Neb. 582 (1908). :>rf!o t>v i po gnfii znoiJinoqioD lo nofocrmol >rf* axhoriJjjf; ^Ibcoid bmj laiiiijj} llij 4 "**mfejjcf lulwjjf vfi u iol CHAPTER XXIII CHARTER THE CORPORATE PURPOSES 215. General An individual or firm may do anything or engage in any form of business not prohibited by the laws. A corporation, on the contrary, may do only those things and engage in those businesses permitted it by the law and set forth in its charter. This renders it important that the charter should clearly and fully empower the corporation to do all those permissible things that may be necessary in its operations. Usually the general corporation laws in each state specify the purposes for which corporations may be organized. In some states these purposes are limited to certain classes of pursuits, and corporations cannot be formed for purposes not specifically included. Mining and manufacturing corporations are authorized in all states. In most states the laws specify mercantile and trading corporations as well. Some states go still further and broadly authorize the formation of corporations for "any lawful business," "any lawful industry or pursuit," or for "pecuniary profit." Under these latter clauses it would be difficult to discover any legitimate calling or pursuit that could not be undertaken by a corporation. The tendency of the present day is towards liberality in this respect and the few limitations that do exist are gradually being removed. 216. Single Purpose Formerly the rule was to organize corporations for a single purpose, as to mine for copper, to manufacture shoes, or to conduct a trading business in some specified line. The authori- 182 Ch. 23] CHARTER CORPORATE PURPOSES 183 zation for this one purpose would, as a matter of course, carry the right with it to do all things necessary or proper to effect that purpose, but nothing further. If another line of business were to be taken up, a new corporation must be organized, as the powers of the old corporation could not be extended to cover the new pursuit. That is, if the members of the copper mining company wished to mine for the precious metals also, they could not secure specific authorization thereto for the old company, but must organize a new company for the purpose. This rule is now almost abrogated. In a few states it is still the law and a corporation will not be chartered for more than one purpose, but generally a corporation will be em- powered for as many legitimate purposes as may be included in the charter application. In some few cases, however, it is still advantageous to confine the corporate activities to one specific purpose. For instance, if a partnership is incorporated, it may be advisable to restrict it to the purposes of the business already under way. This would prevent any subsequent diver- sion of the corporate activity and resources into other and possibly dangerous channels. The corporation could conduct the one business and that alone. It would have no power to venture into new and untried fields. 217. Comprehensive Purposes At the present tune the tendency in corporate organization is towards comprehensive purposes purposes that will permit the corporation to undertake and operate any line of business, in any part of the world, and under any conditions. It is the natural desire to secure all powers and privileges that may be had not that they are all needed or are to be exercised, but unforeseen opportunities may occur when these powers will be required. Incorporators are pleased with these extensive arrays of possible activities, investors and interested parties generally expect them, and as their inclusion is a matter of little difficulty, nearly all modern charters enumerate almost every conceivable 1 84 CORPORATE LAW [Bk. I- branch of business and every kind of enterprise allowable under the statutes. In some cases this has been carried to an absurd extreme, but in general the practice has its advantages. There is no good reason why corporations should not have the same free range of business activities possessed by the individual or firm, and the effort of the present day is to approximate as nearly as may be to this ideal. It is to be noted, however, that this end could be attained with equal efficiency and with much less trouble and verbosity by a few general statements of comprehensive scope. In most cases all the purposes of the most elaborately extended charter could be obtained in their full force and efficiency by a few well- turned phrases. 218. Illegal Purposes No state allows the organization of a corporation for illegal or immoral purposes. Where state officers inadvertently or by intent allow charters for such purposes, the authorization of these charters is void and ineffective and will not protect the stock- holders from any penalties and liabilities that would be visited upon the members of a partnership engaged in similar under- takings. This would apply to any business, occupation, or organiza- tion in direct violation of the laws of the state of incorporation, such as lotteries, gambling, and combinations in restraint of trade. 1 Apart from these manifestly illegal or immoral undertakings, any business purposes not allowed to corporations under the laws of the state are illegal. A charter for any such purpose, even if allowed by the state officials, would be ineffective and the stockholders would be held as partners in case of the in- solvency of the enterprise. This does not often happen at the 1 Peabody v. Gas Trust Co., 130 111. 268 (1889); McGrew v. City Produce Exchange. 83 Term, sia (1886). Ch. 23] CHARTERCORPORATE PURPOSES 185 present day, as most of the states allow incorporation for all proper purposes and the possibility exists only in those states where corporate purposes are still restricted. 2 Also it is to be noted that if some of the purposes are legiti- mate and proper and some unauthorized, the charter is good as to the legitimate portions but is held non-effective and non- existent in those portions unauthorized or in conflict with the laws. The laws cannot be added to or be overridden by a charter provision. 3 219. Things "Ultra Vires" Things otherwise legal, but not specified or implied, among the charter powers of the corporation, are beyond its powers, or ultra vires. Contracts made in pursuance of such unauthor- ized ends cannot be enforced against others, although the corporation itself is usually bound. Directors and officers may make themselves personally liable either to the corpora- tion, to its stockholders, 4 or to third persons, for involving the corporation in such transactions. 5 Both creditors and stockholders have the right to object to any action of the corporation exceeding its legal powers. If, however, the stockholders assent and there are no creditors, there is no one to object to the exercise of powers not authorized by its charter, and the corporate powers may be exceeded without danger to the officers and directors. Owing to the broad powers that are now usually granted, the doctrine of ultra vires has much less importance than for- merly. A modern work on corporations says: The old theory of a corporation was that it could not legally do anything in excess of its express or implied powers. But the Co 444 444 (.1915). 4 Greenfield Savings Bank v. Abercrombie, 211 Mass. 352 (1912); McKinnon v. Morse el al., 177 Fed. S^6 (1910). ., 177 rea. 570 ^910;. * 3 Clark & Marshall on Corp., 5 744d. See, however, Linkhauf v. Lombard, 13? N. Y. 417 (1893). i86 CORPORATE LAW [Bk. I- modern view is that a private corporation may, if all its stock- holders assent and if creditors are paid. Public policy does not require business corporations to confine themselves strictly within the limits of the words of their charters. 8 In case the corporation does exceed its powers and anything goes wrong, the directors and officers might be held personally responsible. When they do business beyond the corporate powers, they take an uncalled-for risk. 6 i Cook on Corp., 3. See also 64 L. R. A., 366 et seq., onimplied powers of corporations. CHAPTER XXIV CHARTER STOCK; LOCATION AND DURATION 220. General Provisions as to Stock In most states the capital stock of a corporation and the divisions and general features of this capital stock must be stated in, and are fixed by, the charter. In a few states, stock with preference or other special features may be issued after the allowance of the charter, by specified action of the stock- holders, but as a general rule everything relating to the stock is fixed once for all by the charter and may be changed there- after only by an amendment of that instrument. Usually the charter states the full amount of the capital stock, its division into common and preferred stock if such division exists, the number of shares into which it is divided, and the par value of each share. The par value is usually the same for all the shares, though not necessarily so, unless re- quired by statute as in California. The par value of the common stock might be fixed at $10 per share, while the par value of the preferred stock were fixed at $100. Generally such variations of the par value are not advisable. 221. Classifications of Stock t'T i/rr-i fr'L- d ' ri Any classifications of the stock should be very clearly set out in the charter. These classifications are varied and numer- ous. The most usual is that of common and preferred stock. This preferred stock may be divided into different classes as to precedence in dividends, or as to amount of dividend, or as to participation in assets, or as to redemption features, or as to participation in dividends beyond preferred dividends, or as to voting or other powers. 187 1 88 CORPORATE LAW [Bk. I- The common stock is sometimes classified in regard to voting powers, each portion or class having the right to elect a certain number of directors, or at times one portion of the common stock may be given the sole right to vote upon certain kinds of questions or under certain contingencies. Such charter classifications are not allowable in all of the states, but the same result may be attained in many cases by suitable by-law enactments unanimously adopted at the first meeting of stockholders. As stated by Judge Folger of the New York Court of Appeals: We know nothing in the constitution or the law that inhibits a corporation from beginning its corporate action by classifying the )[{j shares in its capital stock, with peculiar privileges to one share over another, and thus offering its stock to the public for subscriptions, thereto. 1 222. Common Stock : rf!k>i'-l Usually the charter provisions affecting common stock are few and simple. For example, if a corporation is to be capitalized at $100,000, with shares of the par value of $100, without preferred stock or classifications of the common stock, the charter would merely state that the capital stock is to be $100,000 divided into 1,000 shares of the par value of $100 each. Nothing more would be necessary. The fact that it was all common stock, that this was unclassified, and that there was no preferred stock or restrictions of any kind on the common stock, would be understood without specific statement. If there are to be any classifications of the common stock or any restrictions upon it in any way, these must be stated in the charter specifically and in detail. The mere fact that com- mon stock is usually unrestricted renders it the more necessary to be clear and explicit if restrictions are to be created. 1 Kent v. Quicksilver Mining Co., 78 N. Y. 159, 178 (1879); also Burke v. Gas and El. Co., 123 Pac. (Kans.) 857 (1912); Page v. Whittenton Mfg. Co., 97 N. E. (Mass.) 1006 (1912)- Ch. 24] CHARTER STOCK 189 223. Preferred Stock Preferred stock, by its mere existence, indicates the fact that it has features not possessed by other stock of the corporation, but the differences and preferences which distinguish it should be stated as clearly as possible in the creating clause, and so concisely, if it may be done, that the entire clause may be printed on the face of the preferred stock certificates. It should be borne in mind that unless otherwise provided by the charter, preferred stock has all the rights of common stock in addition to its preference; that is, it would vote, par- ticipate in any dividends in excess of its preferential dividend, participate in any distribution of assets on the dissolution of the corporation, and generally be on exactly the same plane as common stock except as to the indicated preference in divi- dends. If any of these rights are to be denied it, such denial must be clearly expressed. If it is to have any rights other than its preference dividends, these rights must also be clearly indi- cated. Nothing should be left to implication, or be taken for granted. 2 LOCATION AND DURATION 224. Domestic and Foreign Corporations The natural locality in which to incorporate a company is in the state where it is proposed to do business and where its plant or place of business is to be situated. In its own state the state in which it is incorporated a corporation is a "domestic corporation." Elsewhere it is designated a "foreign corporation." In its own state it usually enjoys rights and privileges not accorded a foreign corporation; hence, unless there is some strong reason to the contrary, it should always be incorporated in the state in which the larger part of its business is to be done. See Ch. XI. "Preferred Stock.' IQO CORPORATE LAW [Bk. I- 225. Selection of State The usual inducements for foreign incorporation are the smaller fees and taxes of the selected state. 3 Unless there is a material difference in favor of foreign incorporation, it should be avoided. Corporations organized outside the state are always liable to adverse discrimination, and in many states are at a positive disadvantage in event of litigation. 4 226. Principal Office Usually the location of the office in which the corporation is to have its headquarters must be designated in the charter application. In New Jersey and most of the other states, this principal office must be located definitely. In New York the borough and county in which the principal office may be found must be given, but neither then nor later is any more definite address required. This renders it impossible to secure the local address of a corporation from its charter a seemingly serious omission. The weight of authority is that the location of the principal place of business stated in the charter is con- clusive for the purposes of taxation, 5 jurisdiction of federal courts, 6 and other purposes. 7 It is a general principle of law that stockholders' meetings must be held within the state of incorporation, and the principal office in that state is usually designated by the by-laws as the place where such meetings are to be held. One or two states, by statute provision, permit stockholders' meetings to be held outside the state, but the practice though convenient in some cases is, generally speaking, objectionable. 8 Meetings of both stockholders and directors are usually See Ch. VIII, "Cost of Incorporation." See Ch. VII, "Where to Incorporate." Union Steamboat Co. v. City of Buffalo, 82 N. Y. 351 (1880); Loyd's Executorial Trustees, v. City of Lynchburg, 113 Va. 627 (1912). 6 Lemon v. Imperial Window Glass Co., 199 Fed. 927 (1912). ' In re Federal Contracting Co., 212 Fed. 688 (1914). "See 394, 412, 420. Ch. 24] CHARTER LOCATION AND DURATION 191 held in the principal office in the state of incorporation. To allow meetings of either stockholders or directors to be called elsewhere, unless in places formally designated by the by-laws or agreed to by all parties in interest, gives opportunity for grave abuses. The by-laws should designate the principal office and, unless there is good reason for doing otherwise, prescribe that all corporate meetings be held therein. The principal office in the state of incorporation is- usually designated by the statutes as the place where legal process may be served on the corporation. 227. Duration In some states corporate existence is limited to a fixed period, as twenty or fifty years. In most of the states, how- ever, the duration of a corporation may be made nominally perpetual. This unrestricted duration is advantageous and is in line with the greater liberality manifested towards cor- porations in later years. No serious objection can be urged against it, the reincorporations necessary in the short period states are avoided, and the general stability of the corporation is improved. Where corporate existence is limited by statute, the extreme statutory period is usually selected with the expectation of a reincorporation at its end. At times limited periods are preferred for the corporate existence in order definitely to limit the period of the association undertaking. In such case, at the end of the selected term the corporation expires by limita- tion, its assets are distributed, and the corporate venture is terminated. Usually such distribution is made under some prearranged plan in order to avoid the losses and injury to good- will of a forced liquidation. CHAPTER XXV CHARTER THE BOARD OF DIRECTORS 228. Qualifications At common law it was not required that directors should be stockholders. In most states this has been modified by statute provisions requiring that directors hold one or more shares of stock. Such provisions do not apply unless ex- pressly so stated to directors named in or appointed by the charter. In New York the statute requiring directors to be stockholders may be waived by proper charter or by-law pro- vision, and persons not stockholders may then be selected as directors of the corporation. In general it is very advisable that directors should be stockholders of the corporation in which they act, and the liberality of the laws in permitting persons who are not stock- holders, or who hold but one or two shares, to act as directors, is not in the best interests of stockholders. Occasionally the privilege may be advantageous, but as a general rule the man- agement of a business enterprise cannot safely be placed in the hands of those having no material interest in its success, and the incorporation of an enterprise does not exempt it from this rule. In most states the statutes require that one or more of the directors be residents of the state of incorporation. In such cases, where the parties really interested reside in other states than the one selected for incorporation, resident directors must be secured. In some states, as New Jersey, Maine, and South Dakota, this has led to the organization of concerns whose sole business is supplying of resident directors and the representation of outside corporations organized within the state. At times IQ2 Ch. 25] CHARTER BOARD OF DIRECTORS 193 this has the very unexpected result of giving some dummy director the deciding vote as between two equally divided factions of the board. A recent statute in New York makes the added requirement that at least one of the directors shall be a citizen of the United States. Unless debarred by some statutory prohibition, anyone capable of acting as an agent of a corporation may act as a director. A trustee, or an executor of an estate consisting in part of stock, would be eligible as a director. Under the modern statutes removing their disabilities, married women may act as directors. Unless expressly prohibited by statute, aliens may act as directors. 1 229. Number Some limitation upon the number of directors is usually imposed by the statutes. The exact number within these limits is, in most states, fixed by the charter. In practically all the states a minimum number of directors is fixed by the statutes, though in many no maximum number is prescribed. In general the membership of the board should be fixed at the lowest number that will permit due representation of the various interests involved and provide for the proper trans- action of business. In small or close corporations it is usual to select the minimum number of directors permitted by the statutes. In the larger corporations more directors are usually necessary in order that all the interested parties may be repre- sented, or in order that all the parties really concerned in the management of the corporation may participate in the delibera- tions and actions of the board. Frequently the board is increased far beyond the needs of management in order to secure names that will attract investors and add to the financial stability of the corporation or benefit it in other ways. If the number of directors is made too large it is difficult to secure a quorum, meetings are apt to become infrequent and 1 See i 278. IQ4 CORPORATE LAW [Bk. I- perfunctory, the members of the board do not keep in touch with its business, and some further device must be resorted to for the real conduct of the business. Under such circum- stances the management is sometimes left in an irregular way to the officers and a few actively interested directors; usually, however, the difficulty is met by the appointment of an executive committee, to which is sometimes added a finance committee and upon occasion other special committees. These committees then exercise the powers of management that usually pertain to the board. 2 For the business operations of an ordinary corporation a board of five or seven members actually in control three or four, respectively, forming a quorum is far better than a larger board in nominal control but with special committees doing the real work. 3 230. Authority The stockholders are the owners of the corporate property, but the direct, active, and immediate control rests with the board of directors. The authority of the board exists under the common law, extends to all subjects connected with the manage- ment of the corporate affairs, and, unless in some way restricted, is practically supreme. Its actions in the conduct of the cor- porate business cannot be questioned or interfered with by the stockholders unless in case of gross mismanagement or actual fraud. The property of a corporation is not subject to the control of individual members, whether acting separately or jointly. They can neither encumber nor transfer that property, nor authorize others to do so. The corporation the artificial being created holds the property, and alone can mortgage or transfer it, and the corporation acts only through its officers, subject to the conditions prescribed by law. 4 2 See { 233; also Ch. XXXII, "By-Laws Standing Committees." See 5 278. 'Justice Field in Humphreys v. McKissock, 140 U. S. 304. 312 (1890). Ch. 25] CHARTER BOARD OF DIRECTORS 195 So far as the corporate management is concerned, the stock- holder's position is but little more than that of an interested spectator, s If such unrestrained power in the hands of the board is considered undesirable, it may usually be restricted by charter provision or by-law regulations. In a few states certain re- strictions and hi some cases extensions of the power of directors are found in the statutes. Where special charter provisions are permissible, any desired restrictions upon the power of the board should be incorporated in the charter. If this is not possible they may usually be embodied in the by-laws, where they are equally effective but lack stability, as by-laws are easily changed. By either of these methods the power of the board to incur obligations may be limited; their power to sell the assets of the corporation may be restricted; it may be required that two- thirds or other proportion of the entire number must concur in all expenditures above a certain amount; the payment of excessive salaries may be prohibited; expenditures within a certain period may be limited; and many other restrictions, depending upon the particular conditions, may be imposed." 231. Power to Pass By-Laws The board of directors has no power to pass by-laws or to amend existing by-laws, unless expressly authorized thereto by the statute law of the state, the charter of the corporation, or its by-laws. Where special provisions cannot be included in the charter, the only other legal method of giving the directors power to amend the by-laws is by express by-law provision. It may be advisable that the board shall have power to pass additional by-laws to meet new situations and emergencies as they arise, and where this is so the desired power may be '2 Cook on Corp., {{ 709, 712; 3 Clark & Marshall on Corp., { 6gia; Sellers v. Greer, 172 111. 549 (1898); Ellerman v. Ry Co., 49 N. J. Eq. 217 (1891); Humphreys v. McKissock, 140 U. S. 304 (1890); Denver Engineering Works v. Elkins, 179 Fed. 922 (1909). See Ch. XXVI. "Charter Special Provisions." 196 CORPORATE LAW [Bk. I- given them by an authorization to supplement the by-laws adopted by the stockholders. This is as far as is prudent. To place unrestricted power to make and amend the by-laws in the hands of the board would seem a dangerous and unnec- essary removal of one of the most important safeguards of the corporate form. In the smaller corporations where a stockholders' meeting may be readily called in case of an emergency, there would seem to be no real object or advantage in giving the board any power whatsoever over the by-laws. In the larger corporations that power should only be granted with caution as one that is of but occasional utility and that may be used to the disadvantage of the general corporate interests. 7 232. Classification The classification of directors in such manner that but a portion of the board is elected at any one annual meeting, is at times a convenient and advantageous arrangement. Its object is to prevent the sudden alterations of membership and policy which are always possible where the entire board is elected at one tune, and also to render the selection of desirable members more probable by lessening the number to be elected at any particular time. It is to be noted that the classification of directors is but seldom necessary where cumulative voting prevails, as the sudden change of the entire board that might otherwise result from a passing of the control of the stock of a corporation is then hardly possible. In the smaller corporations classifi- cation of directors is but rarely desirable and is not often found. The most common classification of directors is the division of the board into three classes equal in number, each class holding for three years, and one class being elected each year. Under this plan three years are required for a complete change of the personnel of the board. 7 See JJ 253, 291. Clu 25) CHARTER BOARD OF DIRECTORS 197 Classification of directors is attainable in almost every state. Where permissible, such classification should be pro- vided for in the charter. Where special provisions are not allowed in the charter, it may usually be secured by by-law provision. Unless actually prohibited by the statutes or pre- cluded by implication, such classification may be secured by either charter or by-law provision. It is unusual to provide for more than three classes of di- rectors, and such classified board should preferably consist of some number that will permit three equal divisions, as three, nine, or fifteen. The classes might be made unequal, that is, if the board consisted of eleven members, three might be elected one year, four the next year, and four the third. Such arrange- ment is, however, not common. Upon the organization of a corporation with a classified board the whole number of directors are usually elected at once, the term or class of each director being decided by some agreed method. For instance, in a board of nine members, divided into three equal classes, the three directors receiving the highest number of votes might constitute the longest term class, the three receiving the next highest number of votes the class for the intermediate term, and so on. 8 It is to be noted that the stability of management sought by classification of directors may be secured and at times even more efficiently and conveniently by the creation of a voting trust. 9 233. Standing Committees The board of directors is the managing body of a corporation and supposed to be in direct charge of its affairs. When the board is of moderate size this direct supervision is usually exercised, but when the directors are numerous it is not always See I 282. See Ch. LVI. "Voting Trusts." 198 CORPORATE LAW [Bk. I- practicable, and standing committees are then usually em- ployed. 10 These committees are appointed or elected in such manner as may be prescribed by charter or by-laws; they must be com- posed of members of the board of directors, and, subject to the provisions by which they are created and empowered, usually exercise all the powers of the board in their respective fields. Any necessary number of these committees may be ap- pointed, but they are usually limited to two the executive committee and the finance committee the first-named com- mittee exercising its powers over the general affairs of the corporation, while the powers of the last-named committee are usually confined to matters relating to finance. See Ch. XXXII, "By-LawsStanding Committees." CHAPTER XXVI CHARTER SPECIAL PROVISIONS 234. General The ordinary corporation charter is constructed on a simple pattern and does not permit cumulative voting, classification of directors, limitations on salaries, power to hold stock of other corporations, and other privileges that are generally designated as special provisions. The first general laws relating to incorporations were harsh. Only one purpose was allowed, the privileges granted were few, and all corporations were to be organized and operated on exactly the same lines. Only one mold was provided, and if this did not fit the needs of any particular corporation, relief could be had only by recourse to a special charter or enabling act. These narrow and unnecessary limitations were slowly and grudgingly relaxed, but no marked advance was made until New Jersey recognized the necessity of greater freedom and flexibility, and also perceived the very material advantages that might accrue to the state itself from more liberal corporate legislation. Her legislators then proceeded to remodel the bare laws existing at that time, so as to allow a plurality of purpose, all proper special powers, and a freedom and convenience not theretofore enjoyed by corporations formed under general laws. To this politic concession to the reasonable business demands of the times is principally due the repute and resulting revenue which New Jersey enjoyed and still enjoys as a state for incor- poration. 235. Special Charter Provisions The greater scope and freedom of action of New Jersey corporations under the new law was mainly due to its express 199 200 CORPORATE LAW [Bk. I- recognition of special charter provisions. The right to include such provisions in the charter is conferred by the following clause from the statute: The certificate of incorporation may also contain any provision which the incorporators may choose to insert, for the regulation of the business and for the conduct of the affairs of the corporation, and any provision creating, defining, limiting and regulating the powers of the corporation, the directors and the stockholders, or any class or classes of stockholders; provided such provision be not inconsistent with this act. 1 This enables the incorporators to secure, through charters granted under the general laws, powers, privileges, and regu- lations formerly possible only under special charters. This statute has been followed in Delaware, to a certain extent in New York, and, with more or less variation, in a number of other states. New Jersey lost most of its popularity as a state for incorpor- ation when its legislature made the laws relating to corporations harsh and forbidding. All these repressive measures have now been repealed, and the only cause that hinders the patronage of outside incorporators is the fact that the fees and taxes of Maine and Delaware are much more reasonable. In those states in which special charter provisions are not allowed, many of the desired powers, restrictions, or regulations may be obtained through by-law provisions. In some matters and under some circumstances this may be done effectively, but usually the by-laws may be amended or repealed with comparative ease, and their provisions do not always have the necessary permanence. Where the statutes do not permit special charter provisions, and desired provisions cannot be properly or permanently included in the by-laws, the only recourse is to incorporate in some more liberal state where such provisions are permitted. 1 Laws of 1896 (N. J.), Ch. 185, i 8, p. 280, as amended by Laws of 1898, Ch. 172, p. 408 Ch. 26] CHARTER SPECIAL PROVISIONS 201 The corporation would thereafter operate in its own state as a foreign corporation. Outside incorporation for such a purpose would be justified only where the special provisions obtained were of considerable importance. 236. Usual Objects of Special Provisions Many of the corporate features already discussed, such as cumulative voting, classification of directors, and limita- tions of the directors' power of incurring obligations, are fre- .quently best secured by special charter provisions. In addition to these are many other provisions designed to meet the varying requirements of particular incorporations, such as limitations on the voting power, limitations on salaries, and provisions authorizing a reserve fund or the accumulation of operating capital, etc. In the different states the variation of the statute laws as to special charter provisions is wide. Thus in some states such provisions are not provided for and are therefore not permissible at all; while in other states almost any desired provision is permitted in the charter. In New Jersey by charter provision the directors may be empowered to alter, amend, or repeal by-laws, while in New York the exact power of the board as to by-laws is laid down in the statute law, and cannot be denied or modified in any way by charter pro- visions. Again, in New Jersey the directors may be empowered by trie charter to mortgage any or all of the corporate property without consulting the stockholders; but in New York the cor- porate property may be mortgaged only with the consent of two-thirds of the stockholders of the corporation, and any charter provision to the contrary would be absolutely non- effective. The New Jersey courts have held that a provision in the charter of a corporation that any resolution in writing signed by all of the members of the board of directors should have the same effect as if passed at a duly called meeting, is void, because inconsistent with the provisions of the General Corpora- 202 CORPORATE LAW [Bk. I- tion Law. 2 On account of this wide difference it is necessary to consult the statutes of the particular state when any special provisions are under consideration. 237. Cumulative Voting Cumulative voting is one of the most common and one of the most important of special charter provisions. Its usual purpose is the protection of minority interests by securing to these interests representation on the board of directors. As its name indicates, cumulative voting is a system or method of cumulating or concentrating votes. Under it the owner of stock is, for each share of stock he owns, entitled to as many votes for directors as there are directors to be elected, and at any election of directors he may cast these votes pro rata among all the directors to be elected, or all for one director, or may distribute them among two or more as he sees fit. That is, if the total number of directors to be elected is seven, the owner of one share of stock might cast one vote for each of the seven directors, or might cast seven votes for one director, or cast four votes for one director and three for another, or apportion his seven votes in any other way he chose among the candidates. Under this arrangement it is obvious that even a small minority, by combining on one candidate, may secure repre- sentation on the board. At times this representation becomes of much importance. If the minority are not represented, they are debarred from information of what the majority propose to do or are doing. Under such conditions action may be taken which cannot be undone, but which the minority might have prevented by injunction or other means had they been informed in time. Also the mere presence of a capable minority representative on the board prevents many abuses of power that might otherwise occur. For this and other reasons, cumulative voting is, from the minority standpoint, always a J Audenried v. East Coast Milling; Co., 68 N. J. Eq. 450 (1904). Ch. 26] CHARTER SPECIAL PROVISIONS 203 wise provision and occasionally becomes a matter of the most vital importance. Cumulative voting may, in many states, be secured by proper provision in the charter, and in Colorado the charter must provide whether or not cumulative voting shall be allowed. In Pennsylvania, South Dakota, West Virginia, and a number of other states it is mandatory without reference to any charter provisions. In Nevada it is mandatory unless the charter provides otherwise. In a few states it is doubtful whether the provision would be allowed in the charter or would be effective if included.s 238. Classification of Stock Where special charter provisions are allowed, classification of stock is common. Stock may be classified in many ways. The most usual of these are: the division of the capitalization into common and preferred stock ; division of the preferred stock into classes, as first, second, etc.; and division of the common stock into classes, each class electing a due proportion of the directors. 4 The division into common and preferred stock and the indicated division of preferred stock may be secured by charter provision in nearly every state, together with such other proper classifications of the preferred stock as may be desired. The division of the common stock into voting classes, and the many other classifications occasionally employed, may usually be secured by special charter provision where such pro- visions are allowed. 5 Where permitted by the statutes, the classification of stock may be, and occasionally is, carried into wide variations. Some- times a portion of the stock will be denied the voting right entirely, or will be prohibited from voting on particular ques- 1 See 5533- < See Ch. X, "Stock." ' See { 221. 204 CORPORATE LAW [Bk. I- tions. Certain stock may be debarred from participation in dividends for a stated period. In New York a peculiar partly paid stock may constitute a part of the issue, drawing dividends only upon the amount actually paid in upon it. These unusual arrangements are desirable only under excep- tional circumstances. Generally they are to be avoided as being complicated, unnecessary, and at times of uncertain result. 239. Corporate Stockholding At common law a corporation cannot hold stock in another corporation. Though the law was not formulated with any such intent, its practical effect was to render the formation of trusts and combinations extremely difficult, and in many cases im- possible. New Jersey was the first state to modify the law in this direction and to grant to corporations unlimited power to hold and vote stock in other corporations. Delaware and other states followed the earlier statutes of New Jersey, and in a number of these states, under existing statutes, corporations have the unlimited power first granted in New Jersey. Other states have granted the power within certain limits. New York has followed New Jersey to the extent of allowing this right where provision is made therefor in the charter, or where the corporation whose stock is purchased is of a similar nature, and one with which the purchasing corporation would be authorized to consolidate. The right is, at times, a very valuable one, and in those states where allowed, a provision authorizing the holding of corporate securities by the corporation is usually included in the charter. 240. Limitations on Indebtedness In a large proportion of the cases where corporations are wrecked, the result is brought about by the directors' abuse of See Ch. LVII, "Holding Companies." Ch. 26] CHARTER SPECIAL PROVISIONS 205 the power to incur debt. In those states where the power of the directors in this respect may be limited by charter provision, such restriction is on occasion very desirable. Limitations on indebtedness vary with the conditions. Under some circum- stances it may be desirable to fix an absolute limit beyond which the directors have no power to obligate the corporation. Or it may be provided that if the directors exceed a certain sum, they shall be held personally liable for such excess; or that they shall not enter into any single contract involving obligations over a certain amount; or that obligations beyond a certain amount shall be incurred only with the affirmative vote of two-thirds or other proportion of the whole board, or shall be undertaken only after authorization thereto by due resolution of the stock- holders. Whatever the plan adopted, it should be carefully con- sidered and adapted to the special situation, and the limitations should not be so low as to amount, nor so narrow in application, as to interfere with the ordinary operations of the business. The abuse, not the use, of the debt-incurring power is to be prevented. 7 ,{, ^ It is also to be noted that conditions may arise under which the directors are powerless to prevent corporate indebtedness in excess of charter or by-law limitations. Thus the corporate revenues may be unexpectedly curtailed, but nevertheless with a fine disregard of prohibitory provisions, taxes, rents, official salaries, and other contract obligations continue to roll up a constantly increasing load of corporate debt. In such cases the directors cannot be held accountable, though the limitation has been exceeded. 8 241. Limitations on Salaries The diversion of profits by excessive salaries is a not un- common method of draining a corporate treasury and thereby ' See | 316. 'In re Putnam, 193 Fed. 464 (1911). 206 . CORPORATE LAW [Bk. I- preventing the payment of proper dividends. If not properly guarded against at the time of the organization of the cor- poration, such practice may be extremely difficult to correct or prevent later. 9 Charter provisions imposing limitations on salaries should not be made too narrow or too inflexible. Good management is an absolutely indispensable element of success, and fair salaries, with even more liberal compensation when demanded by the welfare of the company or justified by the excellence of the management, should not be rendered impossible by too narrow restrictions. Flexibility of restriction in the matter of salaries may be provided for in various ways. The charter provision may merely require that salaries be fixed, and varied thereafter if need be, by a two-thirds vote of the entire board. Occasionally the concurrence of the entire board may be required. Or the salaries of officers may be determined each year at the stock- holders' annual meeting by a stated majority of the entire outstanding stock. In such case the required majority may be fixed so high as to require the concurrence of any desired part of the minority interests. Or it may be provided that no official salary shall be increased over a stated figure, until a dividend of, say, 6% has been paid upon the outstanding stock for two or more years. Or any salary payments over a certain minimum might be made absolutely dependent each year upon the pay- ment of a certain dividend for the previous year. It is to be noted that where the ease of alteration is not objectionable, provisions limiting indebtedness and salaries are usually included in the by-laws instead of the charter. Here they may be modified as the circumstances demand, whereas in the charter they may be altered only by formal amendment of that instrument. But to protect the minority effectually, Raynolds v. Diamond Mills Paper Co., 69 N. J. Eq. 299 (1905); Jacobson v. Brooklyn Lumber Co., 184 N. Y. 152 (1906); Davids v. Davids, 135 App. Div. (N. Y.) 206 (1909); Carr v. Kimball. 153 App. Div. (N. Y.) 825 (1912). Ch. 26] CHARTER SPECIAL PROVISIONS 207 such limitations must under ordinary circumstances be inserted in the charter. 242. Sundry Provisions Many other provisions will on occasion be incorporated in the charter. This is especially so in the incorporation of a partnership or the reorganization or consolidation of corpora- tions, when special provisions are often necessary to insure the varying interests, or to carry out agreements entered into as a prerequisite to the proposed arrangement. It is essential that such provisions shall not go counter to any law regulating corporations, and important that they be not such as to involve the corporation in any subsequent deadlock or entanglement. The death of parties, sale of stock to strangers, change of industrial conditions and other mutations may make apparently desirable arrangements exactly the reverse. It is not always possible to amend a charter, and if there is any doubt as to the expediency or effect of any par- ticular provision, it should be brought into the by-laws rather than the charter. Then if found undesirable, it may usually be amended or altered by a mere majority vote of the stockholders. bflfi fadbiib... CHAPTER XXVII CHARTER EXECUTION AND FILING; AMENDMENT 243. General In most states a form of charter application is prepared by the state authorities and will be furnished by them on applica- tion. Where this is not done the forms are usually prepared by law stationers and kept on sale. Care should be exercised in the use of these prepared forms, as they sometimes contain undesir- able features which must be eliminated before the form is used. In some states most of the published forms and notably those for New Jersey and Delaware include the objectionable pro- visions of the trust charters whereby the minimum of power is left with the stockholders and the rights of the minority are reduced to their lowest terms. Such features, while possibly adapted to trust management, are not usually desirable for an ordinary corporation. If any of these prepared forms have received the sanction or approval of the state authorities, such forms should either be used or be closely followed. To depart materially therefrom is to invite objection, which may at times be captious and in any case will cause delay and trouble. The authorities cannot be deemed unreasonable in their preference for forms which have been passed upon, with which they are familiar, and which when used enable them the more readily to determine the legality and correctness of an application. In addition to the usual provisions of the charter, any special provisions desirable for the particular corporation and permissible under the laws of its state will be included and the 208 Ch, a;] CHARTER EXECUTION AND FILING 209 charter application is then ready for the final formalities. These consist of its signing, acknowledgment, and filing. These final formalities are in a general way similar in almost all the states, but as the matter is one of statutory regulation, the laws of the particular state must be consulted for the details of procedure. 244. Signing and Acknowledgment Each of the incorporators must sign and acknowledge the' charter application. If there are but three incorporators and they come together for the signing and acknowledgment of the instrument, the formality is a simple one. The three acknowledgments are taken at the one time and one notarial certificate serves for all. If the notarial officer who acts in the matter calls on the incorporators at their offices or residences and takes their several acknowledgments, the one notarial certificate will still serve. If, however, the incorporators are numerous, live in other states, or for any other reason cannot be easily reached or assembled, separate notarial certificates may be necessary for each acknowledgment. A party to the charter cannot act as notary therein. 1 These acknowledgments may usually be taken by a notary public, commissioner of deeds, justice of the peace, or other officer authorized to take acknowledgments to deeds. If taken in another state, a certificate may be necessary as to the due appointment and authority of the officer by whom the acknowl- edgment is taken. The statutes are in most cases explicit as to the details of acknowledgment, and as the whole matter is one of statutory regulation, these must be closely followed. In some states, in addition to the usual execution by the incorporators it is necessary to secure the approval of the pro- posed incorporation by some designated court, or by a judge of such court, as one of the preliminaries to filing. 1 People, etc. v. Commissioners, 105 App. Div. (N. Y.) 273 (1005). 210 CORPORATE LAW [Bk. I- 245. Filing The technical details of filing the charter application vary to some extent in the different states. In some the application is sent direct to the secretary of state, accompanied by the prescribed fees. In others, the application must be sent direct to the secretary of state, but the filing fees are paid the state treasurer, who before the charter will be filed must certify to the secretary that this has been done. Again in some states the charter must be filed with the clerk of the county court in the home county of the corporation, before filing with the secretary of state; elsewhere the charter must be filed with the clerk of the county court after its filing with the state secretary. The treatment accorded the charter applications by the filing officials also varies in the different states. In some these officials consider that the insertion of unauthorized or im- proper powers gives no legal authority, and that they are not called upon to decide the legal effect of the verbiage employed, and, in accordance with these views, they accept any powers or purposes not openly in conflict with, or glaringly outside the intent of, the law. In other states, on the contrary, the author- ities scrutinize the application in detail, and, if its purposes and powers seem to exceed the statutory limits, decline to file the application. In such case the application is returned with an explanation or statement of the reasons for its refusal. At times the state authorities clearly exceed their authority in passing upon the legality of the indicated powers of a charter application. In such case if the matter were of sufficient importance and the delay not too serious, the courts might be invoked and the points in question be decided by competent authority. Generally, however, the importance of the matter will not justify such proceedings, and if the official ruling cannot be changed the purposes or other matters in question must be either omitted or so changed as to meet the views of the authorities. Ch. 27] CHARTER EXECUTION AND FILING 211 In some states, when an application is approved a charter pro forma is issued under the seal of state granting to the; corporation the desired rights, powers, and privileges. In other states the charter application itself changes its nature, and as soon as filed becomes the charter of the then authorized corporation. Its form is not changed, but its force is, and it is then an authorization from the state for the organization of the corporation with all the powers, privileges, and characteristic features detailed in the one-time application. 246. Alterations If any required alteration in an executed charter is on some non-essential point, and all the incorporators agree thereto, it is not usually necessary to redraft and re-execute the entire instrument. The change may be made in the original instru- ment either as an interpolation or as a correction, and the document be then returned for acceptance in its amended form. When a required alteration is material, the better practice is to have the instrument redrawn and executed afresh by the incorporators. If, however, a material alteration were made in the instrument without any re-execution, but with the consent or subsequent acceptance of the incorporators, and the charter so altered were duly allowed and filed by the state officials, it is not probable that it could later be successfully attacked. 247. Certified Copies In some states, as already said, when a charter application is approved, the secretary of state issues a duly certified- charter under the great seal of state as part of the regular routine. In others, the secretary merely notifies the party filing the applica- tion that it has been accepted and filed, this accepted application then becoming the charter of the corporation. In this latter case the secretary will at any time upon payment of the legal fees furnish certified copies of the accepted application now the charter which is always due legal evidence of incorporation. 212 CORPORATE LAW [Bk. I- Where certified copies of the charter are to be recorded with the local authorities, they must of course be secured from the state authorities as part of the organization routine. Beyond this the possession of a certified copy of the charter is of no importance, save very rarely in cases of litigation, and on occasion for its effect on interested parties or parties to be interested. It is usual, however, to secure and preserve a certified copy among the archives of the corporation. AMENDMENT 248. Charter Amendments The connection between corporate organization and charter amendments is not at first sight obvious. Charter amendments are, however, too often the result of hasty or careless preparation of the original instrument. Also changed or unforeseen condi- tions not infrequently render charter amendments desirable before the corporate organization has been completed. A brief consideration of the subject is therefore in place. New Jersey, with its usual accommodating recognition of possible corporate needs, permits the amendment of a charter by a very simple process at any time before the corporate organ- ization is completed. In this way new conditions may be provided for and the cruder defects of a hastily prepared charter may be easily remedied. Thereafter, as in other states, the charter may be amended only by the regular procedure provided for such cases. Delaware has a like provision. In New York, if there are informalities in the original charter, or defects in its proof or acknowledgment, or if the charter contains any matter not authorized by law, the statute provides a simple method of correcting these defects by permitting the incorporators or directors to file an amended charter. 2 ! Gen. Corp. Law, } 7. Ch. 27] CHARTER AMENDMENT 213 249. Subject Matter Any provisions may be brought into a charter amendment that might have been brought into the original charter. As soon as allowed, the provisions of such amendment become to all legal intents part of the original charter and as permanently binding on the corporation. When an amendment has been made, such amendment and the original charter taken together constitute the working charter of the corporation; the amendment, however, taking precedence over and modifying the original charter in all points of difference. 250. Procedure The procedure for the amendment of a charter is, in each state, prescribed by law. There is but little uniformity in the different states, though in all the procedure is troublesome and at times expensive. In many states the statutory procedure varies with the nature of the amendment. Formerly in New York, to change the name of a coiporation, application had to be made to designated courts. Now the corporate name may be changed by amendment of the charter in the usual way. Generally, an amendment of the charter requires a duly called meeting of the stockholders, at which a two-thirds ma- jority of the stock interests outstanding must vote in favor of the proposed changes. The amendment, duly acknowledged as evidence of the stockholders' authorization, must usually be filed in the same offices and with the same formalities as the original charter. In some states advertisement must be made for a prescribed time before any charter amendment goes into effect. The proportion of the stock vote required, the notices to be given, and the other formalities also vary in the different states. In Delaware a bare majority have power to amend the charter. Part VI The By-Laws 1 CHAPTER XXVIII BY-LAWSGENERAL CONSIDERATIONS 251. Functions of By-Laws A medern corporation is regulated, first, by the general laws under which it operates; second, by the provisions of its charter; and third, by its by-laws. When the incorporators meet pursuant to the authorization of their charter for organ- ization, both the general laws and the charter exist for the guidance of the new corporation. To these must be added the by-laws to provide for such details of organization, adminis- tration, and business routine as are not prescribed by the laws nor provided for in the charter. This is the first and most important function of the by-laws. Beyond this any special provisions for the regulation of the corporation, its directors, officers, or membership may be incorporated in the by-laws when such provisions are not permitted in the charter or when the permanence of a charter provision is not desired. In addition the by-laws are also usually so drawn as to constitute a systematic statement of the more important working details of both the general law and the charter. This is not done with any idea of adding to the binding force of the require- ments of these higher authorities, but merely as a restatement, the by-laws being thereby rendered a more complete code for the guidance of the corporate officials and stockholders. This use of the by-laws is customary and of considerable See Book IV, Ch. Ill, "Bv-Law Forms." 215 216 CORPORATE LAW [Bk. I- importance, helping to secure the observance of those statutory and charter provisions which, if not in such accessible form, might be overlooked or forgotten. 252. Subject Matter of By-Laws There is usually no law, save the law of necessity, com- pelling a new corporation to adopt by-laws. Its operation without by-laws would, however, be practically impossible so much so, that the law confers the power to make by-laws and takes it for granted that this right will be exercised. Pro- visions for the regulation of the corporation are found both in the statute law and the charter, but these are for the most part general in their nature. There are none of the specific details essential for proper corporate operation. Just what matters should be provided for in the charter and what in the by-laws is to some extent determined by the conditions of the particular corporation. The statutes usually prescribe certain essential matters that must appear in the charter. In addition all such important matters outside the ordinary routine of corporate procedure, as are intended to be permanent features of the organization, should be incorporated in the charter.2 Beyond this, however, the routine details of corporate procedure, and any special provisions which are not intended to be permanent or which are not permissible in the charter, are reserved for the by-laws. Generally speaking, nothing should be incorporated in the charter that may be as effectually pro- vided for in the by-laws. The by-laws, as has been stated, also usually contain many provisions of the statute law and the charter which are repeated in the proper connection in the by-laws merely that these latter may, in themselves, be a complete working code. The by-laws will, then, contain all the ordinary working details of corporate regulation and most, if not all, of the important statutory and 1 See Ch. XXVI, "Charter Special Provisions." Ch. 28] BY-LAWS GENERAL CONSIDERATIONS 217 charter provisions directly affecting the. corporation ; frequent reference to the charter and to the statutes being thereby ren- dered unnecessary. Under the head of routine details, the by-laws should, in strict conformity with any requirements of statutes or charter, provide for the issuance and transfer of stock, the meetings of stockholders and directors, the election of directors and officers, the duties and limitations imposed upon these, the care and management of the property and finances of the corporation, and the other connected incidents of corporate procedure. There are certain general restrictions upon the making of by-laws which the courts will enforce : 1. By-laws must not be inconsistent with the existing laws or with the charter of the corporation. 3 2. They must not operate unequally upon any of the class which they are intended to govern. 4 3. They must not impair any vested right of any stock- holder. 5 4. They must not be unreasonable. 8 253. Power to Make By-Laws The power to make by-laws is one of the common law powers enjoyed by corporations. Where the common law still prevails, the right to make by-laws resides in the stock- holders duly assembled in lawful meeting. Power to make by-laws may be delegated by the stockholders to the directors, but may be resumed at any time by the stockholders, and may be exercised by the directors only under such limitations as the stockholders prescribe. This power over the by-laws is perhaps the most important right reserved to the stockholders. This is so because, as already stated, the stockholders Raub v. Gerken, 127 App. Div. (N. Y.) 42 (1908); People v. Ittner, 165 111. App. 360 (1911). 4 Griffith v. Klamath Water Users' Assn., 137 Pac. (Ore.) 226 (1913); 10 Cyc. 336, and cases cited. ' State v. Board, etc., 164 S. W. (Tenn.) 1131 (1914); Wright v. Knights of the Maccabees, 196 N. Y. 391 (1909). State v. Mayor, etc., of Jersey City, 37 N. J. L. 348 (1873). 2i8 CORPORATE LAW [Bk. I- cannot manage the affairs of their corporation directly but only through the board of directors. This board is not amen- able to either request or resolution of the stockholders and has wide latitude and great independent power in the management of the corporate affairs and property. If any restrictions are to be imposed upon the directors' powers, recourse must be had to special charter or by-law provisions. Special charter provisions are of limited application and not always available, and in most cases the wishes of the stockholders as to the man- agement of their property and business must be expressed in the by-laws, and can be effectively expressed in no other way. For this reason anything affecting the stockholders' sole right to make, repeal, and amend these by-laws is a matter of vital imDortance. 254. Power of Directors to Make By-Laws In New Jersey and those other states which have modeled after her corporation laws, the charter may be so worded as to give the directors power to make and amend by-laws. This gives the directors the power to alter the regulations by which they themselves are controlled. The expediency of such an arrangement is exceedingly doubtful, even in the large industrial combinations for whose benefit it was devised. Its tendency is to put much power into the hands of the directors and of the majority stockholders by whom such directors are elected, and to diminish correspondingly the status and power of the minority stockholders. In New York the directors are by statute provision given the power to adopt by-laws not inconsistent with those passed by the stockholders. This would seem to be quite as far as it is safe to go. It allows the directors to pass by-laws to meet an emergency, to provide for new conditions, or to supplement and make more effective the stockholders' by-laws, and they are fully within their powers so long as these by-laws do not conflict with the by-laws adopted by the stockholders. The Ch. 28] BY-LAWSGENERAL CONSIDERATIONS 219 directors cannot, however, remove any of the safeguards thrown round the conduct of the business by the by-laws of the stock- holders, nor modify the stockholders' by-laws in any material respect. They may act in harmony with what has gone before, but cannot alter or destroy. It is to be noted that such directors' by-laws, until repealed or superseded by action of the stock- holders, are the by-laws of the company and of equal force with those adopted by the stockholders. If the original by-laws are adopted by the directors, these by-laws are the law of the corporation, and can be amended by the directors, subject, however, to amendment or repeal at the hands of the stock- holders. 7 In Illinois, by a rather strange perversion of the corporate theory of government the directors, by statute, have power to make by-laws and the stockholders have power neither to make nor amend the by-laws. 8 255. Arrangement of By-Laws By-laws intended for a close corporation with but few stock- holders and perhaps all these on the board of directors, may be simple in form and few in number. When intended for one of the great corporate combinations with plants in many different states, with thousands of stockholders scattered throughout the Union, with a large Directorate, many officers, and numerous managing committees, an extensive and comprehensive set of by-laws is usually considered essential. In either of these cases, and for the many intermediate corporations, it is of much advantage to have the by-laws classified and systematized so that the regulations governing any particular subject or matter may be readily found. In all the better prepared sets of by-laws this systematic classifi- cation is employed. In many cases, however, the by-laws are hardly more than a heterogeneous jumble of unconnected 7 See 55 231, 291. 'Steinweg v. Antiseptol Liquid Soap Co., 168 111. App. 479 (1912). 220 CORPORATE LAW [Bk. I- regulations, badly balanced, incomplete, difficult in operation, and because of this, the less likely to be observed. In the present volume the related provisions of the by-laws are grouped in the order and under the headings given below. This arrangement is used by a number of the best organized corporations of the country and has proved very satisfactory in practice. By-laws from the simplest to the most comprehensive sets may be readily classified on these lines: 1. Stock 2. Stockholders 3. Directors 4. Standing committees 5. Officers 6. Dividends and finance 7. Sundry provisions 8. Amendments 256. Preparation of By-Laws The by-laws usually prescribe the general organization of the corporation, and the adoption of by-laws is therefore the first important step in organizing a corporation. As the by- laws are needed so early in the corporate existence, they are customarily prepared in advance of the first meeting, this duty usually and properly falling upon the counsel conducting the organization of the corporation. The preparation of a set of by-laws for the usual small corporation is a comparatively simple matter. For the larger corporations, with their more complex and extended organi- zations, the undertaking is much more difficult. Such by-laws should be prepared with nice adaptation to the needs of the particular corporation. The use of an existing set of by-laws as a basis for this work is entirely proper and good practice, but such selected set should be carefully studied and properly adapted to the wants of the new corporation. All unnecessary matter should be dropped, the matter that is retained be made Ch. 28] BY-LAWSGENERAL CONSIDERATIONS 221 to fit the case in hand, and such new matter added as may be necessary to cover the requirements of the particular corpor- ation. Too often the preparation of the by-laws of a new corpora- tion is merely a wholesale seizure of some existing set with hastily improvised interpolations to meet the most obvious individual needs of the new organization. These by-laws may have been a very admirable code of procedure for the original corporation, but so diverted they can hardly fail to be a wretched misfit and prove a fruitful source of trouble. By-laws so ill-prepared give seeming grounds for the demand that the directors be given the power to amend by-laws as the only means of avoiding serious hindrance and injury to the business. 257. Adoption of First By-Laws 9 The preparation of by-laws requires careful consideration, and it is usually impossible to take sufficient time at the first meeting to prepare by-laws or even properly to discuss and amend a previously prepared set. This being so, the responsi- bility for the by-laws rests almost entirely with the lawyers to whom their preparation is entrusted. If the by-laws are to be adopted formally, this is accomplished by the reading of each section and its adoption by vote, followed by the adoption of the set as a whole at the completion of the sectional considera- tion. Usually, however, the by-laws are presented to the meeting in their entirety, and, without reading or other investi- gation of their details, are either adopted by formal vote or accepted by acquiescence. The legal effect of such adoption is the same as under the more formal procedure. See i 330. CHAPTER XXIX BY-LAWSSTOCK 258. Preliminary The subject of stock which is considered first in the following comment is one of the most important matters of by-law regula- tion. In most of the states general requirements relating to the stock of the corporation, its certificates, its transfer and record, are matters of statutory regulation. These statutes should be summarized and classified in the by-laws and such additional special regulations brought in as will cover the entire working details of the subject. No open question should be left to cause later differences of opinion, vexations, disputes, and perhaps more serious difficulties. In former days, when preliminary subscriptions to the stock of a corporation were usual and in many cases payable in instal- ments, a by-law provision as to the payment of these instalments and the procedure in case of default was customary and of some importance. In the present day, however, the formation of a corporation with instalment subscriptions is comparatively rare, and when it does occur collection of the subscriptions is usually provided for by resolution of the directors. This avoids cum- bering the by-laws with matter that is of no permanent utility. 259. Certificates of Stock Every owner of stock for which the corporation has been paid in full is entitled to a certificate or certificates, showing the num- ber of full-paid shares of stock owned by him. A subscriber, when his subscription is accepted, becomes a stockholder of the company and entitled to vote and draw dividends if any are declared, but is not entitled to a certificate of full-paid stock until Ch. 29] BY-LAWSSTOCK 223 he has paid the full subscription price of his stock. If he has paid in part he is entitled to a receipt evidencing such payment, and if the by-laws so provide, or if the corporation makes a practice of issuing certificates for partly paid stock with the amount of payments indorsed thereon, he has a right to demand such a certificate as soon as his first instalment is paid. In the absence of such by-law provision or of such a custom, it does not appear that a stockholder has any legal right to a stock certificate until he has paid in full for the stock represented thereby. It would be the better practice to issue no certificates of stock until the stock represented by such certificates is full-paid. The holder of a certificate of stock has the right to assign the same to others, or to surrender it and, if for more than one share, have it split up and issued as he directs in certificates of total equivalent value. An assignee of stock has the same right, and whenever a duly assigned certificate is surrendered to the com- pany a new certificate or certificates must be issued to the assig- nee in his own name if so demanded. If transfers with reissues of certificates are frequent, it may be advisable to impose a small transfer fee usually varying from 10 to 25 cents for each certif- icate issued for the benefit of the secretary or other issuing officer. This is occasionally a very convenient regulation as it compensates the secretary for the time and labor involved in the issue of new certificates and also tends to restrain unnecessary transfers. Such a fee, if reasonable in amount, will be upheld. 1 By-law specifications as to the signature and sealing of certi- ficates are useful as prescribing in detail the execution of the certificate and the duties of the different officers concerned. Such by-law regulations must, as a matter of course, follow any statute provisions. In most states the statutes provide for the signature of stock certificates by two officers of the corporation. In some states the statutes designate the president as one of these officers, leaving to the corporation the designation of the 1 See 5 344; also Giesen v. L. & N. Mortgage Co., 102 Fed. 584 (1900). 224 CORPORATE LAW [Bk I- second officer; in other states the designation of both officers is left to the corporation. No matter who the signing officers may be, the sealing and actual issuing of the certificate is usually left to the secretary. 2 260. Transfers of Stock General regulations regarding the transfer of stock as well as the times of closing the stock books, are in many states a matter of statutory provision, but may also properly appear in the by- laws with any other connected matter. The procedure for the transfer of stock should be plainly outlined in the by-laws as a guide to the officers of the corporation, and, more particularly, for the benefit of the stockholders who are thereby informed as to their exact rights in the matters 261. Transfer Agent and Registrar In the larger corporations, or in any corporation where the transfers of stock are numerous, the employment of special transfer agents and registrars is usually a considerable advantage. By this means the officers are relieved of much responsibility, and a safety and a convenience in the issuance of stock secured not usually possible under any other arrangement. For a small or close corporation where transfers are few, the employment of such agents is a needless expense. Where transfer agents and registrars are to be employed, the by-laws should give the power to appoint these to either the board of directors or to one of the standing committees. The by-law provision covering this matter should also require the signature of the transfer agent and of the registrar to every certificate issued. Where a trust company is to be appointed as transfer agent or registrar and the appointment is of probable permanence, such appointee is sometimes named in the same by-law provision. As this necessitates an amendment of the 2 See J 97. ' See Chs. XXXVIII and XXXIX, "Transfer of Stock"; also Book III, IS 42, 43. Ch. 29] . BY-LAWSSTOCK 225 by-laws in case of any change, the arrangement is of doubtful expediency. The duties of a transfer agent and of a registrar are distinct but are usually performed by one person or institution. 4 262. Stock and Transfer Books All requirements as to the stock and transfer books should appear in the by-laws. To this end the statute laws must be carefully consulted as to what books must be kept, where they must be kept, and what they must contain. New Jersey cor- porations are required to keep their stock and transfer books in the principal office of the corporation in New Jersey. If it is desirable that duplicates be kept elsewhere, the by-laws might properly so provide. Every foreign corporation doing business in New York is compelled to keep a stock book in the principal office of the company in the state. Hence the by-laws of a corporation organized under the New Jersey laws and doing business in New York might very well specify in this particular the duties of the corporation in both states. It is usual to close the transfer books a certain number of days before the annual meeting, and during this period stock cannot be transferred on the corporate records. If this closing of the transfer books has not already been provided for in the by-laws relating to the transfer of stock, it should receive attention here. It is also usual to provide for the closing of the transfer books a certain number of days before dividends are paid, and any pro- viso as to this closing might be covered in connection with the closing of the transfer books for the annual meeting. 5 263. Preferred Stock The preferred stock of a corporation will probably have been specifically provided for in the charter. It is customary, how- ever, to repeat such provisions in the by-laws for easy reference See 5 358; also Wills, Estates, and Trusts, by T. Conyngton el al., Ch. LXI. See Book III, 55 38-43; also Book IV, Ch. VII, "Stock Books" (forms). 226 CORPORATE LAW [Bk. I- and for the information of the stockholders. As all the details relating to preferred stock are usually found in the charter provisions by which such stock is created, the by-law will be merely a more or less complete repetition of the charter specifica- tions. In 'some few states preferred stock is authorized by the provisions of the by-laws, which in such event become of much more moment and should be drawn with the same care and regard for the necessities of the case as would any charter pro- vision. The by-law authorizing the issue of preferred stock cannot be materially altered or amended after stock has been sold under its terms, except with the consent of the holders of the outstanding preferred stock. If it were modified without such consent, the changes would be ineffective as regards out- standing stock, unless accepted by its holders. 6 264. Treasury Stock The term "treasury stock" is used very loosely, and, with- out some defining provision, ambiguities are apt to arise. For this reason a provision is frequently brought into the by-laws for the purpose of defining the term and the status of treasury stock. Such a by-law is advisable if the corporation is likely to have stock of the kind. The status of this treasury stock is, where not expressly fixed by statute, a matter of common law, but should neverthe- less be clearly expressed in the by-laws as a matter of information for both officers and stockholders. 7 265. Lost Certificates The loss of stock certificates is a matter of not uncommon occurrence, and the procedure in such cases should be clearly outlined in the by-laws. Stockholders have a right to certifi- cates and, if their certificates are lost, to have them replaced, but the corporation on its part has the right to require any See Ch. XI, "Preferred Stock." ' See Ch. XIII, "Treasury Stock." Ch. 29] BY-LAWSSTOCK 227 reasonable safeguards for its own protection before the reissuance of such certificates. If the statutes prescribe the procedure to be followed, the by-law provisions must correspond. It is seldom wise to reissue lost certificates on easier terms than those laid down in the usual by-law form.s Only the absolute and final loss of a certificate, as in the case of its unquestioned de- struction by fire, would justify an unprotected reissue. 266. Fractional Shares Some few corporations issue fractional shares, though there is no legal authority for such action. It would seem undesirable on every account. Apart from the complexity of records and accounts, troublesome questions might arise as to legal rights of holders. What voting or dividend rights would a man have who owned, say, 9/17 of a share of stock? If a man sells a fractional interest or interests in a share of stock, he and the other parties would be entitled to have a certificate issued in their joint names, would own the share in common, and would have to arrange among themselves as to custody, voting, and dividends. The corporation need not concern itself with the transaction. See Book IV Ch. Ill, "By-Law Forms. 1 ; J CHAPTER XXX BY-LAWS STOCKHOLDERS 267. Annual Meetings An annual meeting of stockholders at which directors for the ensuing year are elected is usually required by the statutes. Whether or not so required, such meeting should be provided for in the by-laws. It is the most important function of the stockholders, and the portion of the by-laws devoted to the stock- holders is principally occupied with provisions relating to the annual meeting. In specifying the time of the annual meeting it is advisable not to specify a fixed day of the month, as, for instance "January 26," but to fix the date in some such form as "the third Monday in January." The reason for this is that if the specified date as first given falls on a holiday or a Sunday, upon which the meeting cannot be held, various questions may arise as to the validity of the corporation's proceedings. It is also a good precaution to name the time of the day at which the meeting is to be held, as precision in specifying the time and place may at some time be much needed in case notice of the annual meeting should be defective. If the hour of the meeting is not specified, it has been held that the by-law is not sufficient notice to the stockholders. 1 In fixing the date of the annual meeting it is generally well to fix it shortly after the end of 'the fiscal year of the corporation so that the financial report to the stockholders may be com- prehensive. For the same reason, the place should be definitely fixed, 1 Lowe v. Los Angeles Suburban Gas Co., 24 Cal. App. 367 (1914)- 228 Ch. 30] BY-LAWS STOCKHOLDERS 229 and except where it is expressly provided by statute, as in Delaware and a few other states, that the stockholders' meetings may be held out of the state the place designated must be in the state of incorporation. The by-laws providing for the annual meeting, in addition to fixing the time and place, should in a general way specify the proceedings of that meeting. This specification of the business to be transacted at the annual meeting is not mandatory. Any portion of it can be waived by the meeting at will. Nor is it intended to limit the stockholders' proceedings in any way unless expressly so stated in the charter or by-laws. It is always ex- pected that in addition to the specified procedure, any other business or matters of interest to the stockholders will be con- sidered, and the order of business is included in the by-laws merely to prevent important action being omitted or overlooked and as a matter of convenience. 268. Special Meetings The by-laws must provide for special meetings of the stock- holders, and fix the preliminary requirements for such meetings. Frequently the president is given authority to call special meet- ings at his discretion; it is always customary to provide for such meetings to be held pursuant to resolution or other specified action of the board; at times it is provided that a certain number of the directors may call special meetings by a written request or call; it is also customary and proper to allow these special meet- ings to be called on demand of a certain proportion in interest of the stockholders usually one-third or a majority of the out- standing stock. It is usual to prescribe in the by-laws that only such business as is specified in the call and notice shall be transacted at a special meeting of stockholders. This is a matter of common law, and in some states statutory law, and is included in the by- laws merely to emphasize the fact that any business to be done at any such meeting must be previously notified to the stock- 230 CORPORATE LAW [Bk. I- holders. The call and notice, to be sufficient, must give the three essential facts the time, place, and purpose of the meeting. If any one of these is omitted, the meeting is improperly called and its action is liable to be held illegal and may be set aside. 269. Officers of Meetings It is customary in some corporations to organize each stock- holders' meeting with officers of its own choosing, who may or may not be the regular officers of the corporation. Under some conditions this plan may be a wise one, but generally it would seem better to provide in the by-laws that the officers of the corporation shall also be the officers of the stockholders' meet- ings. In such case the president, or in his absence the other officials in due order, preside, while the secretary keeps the records of the meeting. Such an arrangement saves much con- fusion and loss of time on occasion, and conduces to the orderly transaction and proper record of the business of the meeting. The secretary is usually and properly omitted from the officials who may preside. The function of this officer is to record the proceedings of the meeting and it would not be advantageous to withdraw him from his proper duties to preside, even though all the other officers were absent. 270. Notice of Meetings Unless there is some material reason for not so doing, it will be found advantageous to adopt the same requirements as to time and character of notice for both regular and special meet- ings. When this is done the requirements as to notice may be properly included in a single by-law section. Where the notices for the two kinds of meeting differ materially, the details for each meeting should occupy a separate subsection under the sections providing for annual and special meetings. The notice of regular meetings should specify the time, the place, and usually the most important objects of the meeting. Where unusual business is to be transacted, even at a regular Ch. 30] BY-LAWS STOCKHOLDERS 231 meeting, the notice of the meeting should state that unusual business. 2 The notice for special meetings should give the time and place of meeting, and specify in detail all the business to be acted upon at that meeting. Where a corporation has but few stockholders, the provisions as to notice of meetings will sometimes include the following provision for special meetings: "With the presence and par- ticipation, or with the consent of all the stockholders, meetings may be held at any time and place and for the transaction of any business, without notice." Notice of meetings is best given through the regular postal channels; personal notice is allowable, but should always be served in writing. Verbal notice, while legally held sufficient, is objectionable because it is usually difficult and sometimes im- possible of proof. Unless expressly authorized in the by-laws, notice by telephone is not sufficient and in any such case service could not be legally proved. By-laws as to notice of meetings should include all statutory requirements of publication or mail- ing of notices. 271. Voting The usual rule in regard to voting is that each stockholder of a corporation is entitled to one vote for each share of stock standing in his name on the books of the corporation. If there are any variations, such as cumulative voting, classified voting, or reservation of voting to one class of stock, such variation should be stated as clearly as possible. Perspicuity and pre- cision in the by-laws relating to voting may save much trouble later. Such provisions must conform to any state statutes. 272. Certified List of Stockholders Under the laws of New Jersey and of some other states, at each regular meeting of the stockholders of a corporation a 1 2 Cook on Corp., 595. 232 CORPORATE LAW [Bk. I- certified list of the stockholders entitled to vote thereat must be provided by the secretary. In any state the provision is a satisfactory one and may well be included in the by-laws, either as a separate section, or as a part of the by-law providing for annual meetings of the stockholders. It is to be noted that the stock books are the final authority as to the right of any stock- holder to vote, and the certified list of stockholders cannot be made a substitute for the stock book, which should be accessible in case of dispute. The certified list will, however, usually be found all sufficient, saving reference to the stock book and giving its information in much more convenient form. The list should be alphabetically arranged. 273. Election of Directors As the election of directors is the most important business of the annual meeting, the by-law directions for its conduct should be very explicit. If, as is the case in certain states, the statutes require the election or appointment of inspectors who are usually sworn to the proper discharge of their duties the details of their appointment and duties should be fully outlined. If inspectors are not prescribed by statute and are not desired, some other method of conducting the election should be specified. It is usually advisable that it be by ballot, though this is not essential save when prescribed by statute. If by ballot, pro- vision must be made for the appointment of tellers to collect, count, and announce the vote. Unless included in the by-law on voting, any provisions as to cumulative voting, or as to classification of the stock in regard to voting, should be given here. Also, if the directors are classified so that but one-third or one-fourth are elected each year, such fact should be stated under this heading. The term for which the directors are elected should also be stated clearly. Usually this is for the ensuing year and until the election of their duly qualified successors. The directors Ch. 30] BY-LAWS STOCKHOLDERS 233 hold until the election of their successors in any event, but the by-laws should state the fact. 3 274. Quorum In a number of the states the proportionate amount of the outstanding stock which must be represented at a stockholders' meeting to constitute a quorum is fixed by statute. In such case the by-laws can do nothing more than repeat the law in order that it may be remembered and observed. If the statutes do not so provide, the quorum should be distinctly prescribed by the by-laws. If not provided by either statute or by-law, the common law rule prevails, that the stockholders present, no matter how few their number, constitute a quorum. 4 In the absence of any statutory provisions to the contrary, the by-laws may provide that less than a majority of the out- standing stock shall constitute a quorum; but for most corpo- rations it is not safe to depart from the usual parliamentary rule that a majority of the outstanding stock is necessary to consti- tute a quorum. To illustrate the necessity of a careful consultation of the statutes in this matter and in matters of corporate procedure generally, attention may be called to the fact that in New York the by-laws may prescribe the number necessary to constitute a quorum at stockholders' meetings for ordinary business, but cannot fix a quorum for the election of directors, those present at any annual meeting being a sufficient quorum for this purpose no matter how few their number or how small a proportion of the outstanding stock they represent. This is but a special application of the general common law rule that those present at a meeting of constituent members form a quorum and may act. It is to be noted that this common law rule applies only to the constituent membership of a body, such as the stockholders 2 Cook on Corp.. f 624; 3 Ibid., f 713. See,J 402. 234 CORPORATE LAW [Bk. I] of a corporation. The directors, being a selected body, require a majority of the entire board to constitute a legal quorum. 5 275. Proxies Proxies play such an important part in all corporate meet- ings that the by-law provisions relating to them should be clear and explicit. At common law the stockholder does not have the right to be represented at corporate meetings by a proxy. The right is given by stature in many states, and elsewhere proxies may be authorized by charter provision, or in most states by by-law enactment. Where created by statute, the by-law provision must follow the statute. 276. Order of Business The order of business is purely formal but quite essential to the proper transaction of the corporate business. It may be varied to meet the needs of any particular corporation. The order given in the by-law forms 6 indicates the usual and logical arrangement. The formal order of business may be suspended at any meeting, in whole or in part, by a majority vote of those present, or by their mere assent. s i Morawetz, 2nd Ed., 476; 2 Kent's Com., 293; Matter of Rapid Transit Ferry 15 App. Div. (N. Y.) 530 (1897). 6 See Book IV, Ch. Ill, " By-Law Forms." CHAPTER XXXI BY-LAWS THE BOARD OF DIRECTORS 277. General Considerations Regulations affecting the directors and any restrictions upon their powers and action will,for the most part, appear only in the by-laws. Statutory provisions of general scope are found in practically all the states, more specific provisions appear in some states, and especially important matters are sometimes brought into the charter; but in the main the stockholders must look to the by-laws to direct and control the operations of their directors. Much latitude is allowable in the arrangement of the by- laws affecting directors. In the larger corporations the subdi- visions are frequently carried further than indicated in the present chapter; in the smaller corporations, ordinarily not r so far. Many of the details appearing in the by-laws affecting direc- tors are matters of law, or are fixed by charter provision and are brought into the by-laws merely to save reference to the authorities from which they are taken. 278. Number In many states the number of directors is, within certain minimum and maximum limits, fixed by statute. In some states, as New Jersey and Massachusetts, the minimum is pre- scribed by statute and any number in excess of this minimum may be fixed by the by-laws. In most states the minimum number of directors allowed is three. For a small or close corporation a limited board of directors is usually advantageous. Such a board is easily assembled, is 235 236 CORPORATE LAW [Bk. I- likely to keep in touch with the business, and is generally prompt in consideration and action. In the larger corporations a more numerous directory is usual. Frequently this is necessary in order to provide represen- tation for the different stockholding interests, as well as to have the requisite managing representatives upon the board. Though necessary, the arrangement has many disadvantages. A quorum is only secured with difficulty; the members are not close to the business and are not interested actively in its man- agement, and lengthy explanations, much discussion, and pro- longed consideration are the rule when important questions are really taken up. As a result the actual management of the business and of the corporate affairs is delegated to the standing committees, the board meeting only to listen to reports, or to act in matters of exceptional importance. i 279. Qualifications The most common qualification required of a director is the ownership of stock. This is usually regulated by statute. In some states such qualifying stock must be owned when the direc- tor is elected. In most states, if the director-elect is given or secures stock after his election, the requirements of the law are held to be satisfied. If the statutes merely state that directors must be stockholders, the ownership of one share of stock is sufficient. If the statutes are silent on the subject of stock qualifications of directors, or if they require merely that directors be stockholders, the by-laws may legally provide that such rea- sonable number of shares as may seem desirable shall be the qualification. In some states it is provided that a director parting with his qualifying stock thereby ipso facto ceases to be a director. In order to prevent any misunderstanding on this point, the by- laws should repeat the statute provision where it exists. Else- where it would be prudent to state explicitly either that the 1 See i 229. Ch. 31] BY-LAWS BOARD OF DIRECTORS 237 parting with the qualifying stock does or does not terminate the director's tenure of office. As a general rule it would seem advisable that directors should be stockholders, of the corpora- tion to some material extent, and that if they part with this qualifying stock they should by such disposal sever their official connection with the board. 2 If there is any statutory requirement as to citizenship of directors, it should be included in the by-laws. 280. General Powers At common law the directors have entire charge of the property and affairs of the corporation with full power and authority to manage and conduct the same. The statement of the general powers of the directors as it usually appears in the by-laws is therefore nothing more than a reiteration of the con- ditions as they exist, brought into the by-laws as a matter of information. If the powers of the directors are materially modified or restricted by the statutes, by the charter of the corporation, or by the by-laws themselves in other parts, the by-law statement of general powers should be drawn to cor- respond. 3 281. Term of Office The statutes in most states provide that the directors shall be elected annually, and shall hold over until their successors are elected and qualify. When the statutes so provide, no by- law provision for a longer term would be valid. In many of the states, however, classification whereby only part of the directors are elected each year is provided for. The by-laws should in any event contain provisions as to the term of office of the directors, and the provision that they shall hold over until their successors are elected and qualify. * See f 228. "See J{ 230, 231. 238 CORPORATE LAW fBk. I- 282. Classification The usual object of a classification of directors is to provide against any radical action or sudden alteration of policy that might occur if the whole board were changed at one time. In perhaps the greater number of states it must, when desired, be secured through by-law provision. To be effective any such classification of directors must be permanent, and therefore, wherever possible, should be by charter provision. If dependent only upon the provisions of the by-laws, a majority of the stockholders might at any time assemble with due formality, repeal the by-laws in question, and thereby abrogate the whole arrangement. 4 Classification in a small or close corporation is generally a useless and somewhat troublesome formality. 283. Removal It may infrequently happen that the stockholders wish to have more control over the board than they have under the com- mon law, and wish to reserve to themselves the power of removal of directors without the troublesome procedure necessary to remove them for adequate cause. If the statute does not give them this power, and their charter does not, provision may be made in the by-laws, and a director accepting office under a by-law giving the stockholders power of removal will be bound thereby. 5 284. Vacancies The board of directors is usually given power to fill vacancies occurring in its own body. Unless, however, it is so provided by statute, charter, or by-laws, the board does not have this power, and in such event the power is reserved to the stockholders. Any vacancies in the board must then either wait until the next annual See 232. s Douglass v. Merchants' Ins. Co., 118 N. Y. 484 (1890); Raub v. Gerken. 127 App. Div. fN. Y.) 42 (iooA. Ch. 31] BY-LAWS BOARD OF DIRECTORS 233 meeting with its election of directors, or be filled by a special election, the stockholders being called together for the purpose. 6 As long as the board can assemble a quorum of its entire membership, it may continue to act despite vacancies, but it is safer to keep the membership up to the prescribed quota, and it is almost an invariable rule to give the board the power to fill vacancies as they occur. In this way the board is self -per- petuating in the intervals between the annual meetings. The usual board vacancies provided for by the by-laws are those caused by death or resignation. Beyond this the by-laws might very properly provide that continued absence from meet-, ings of the board should, in itself, vacate the position of the absentee director. In such case the by-laws should specify the exact number of consecutive absences from regular meetings, or from . regular and special meetings, necessary to create a vacancy. By-laws sometimes provide that in case the membership of the board falls below the number required for a quorum, so that the board is unable either to transact business, or to fill the va- cancies and thereby re-establish a quorum to enable it to transact business, a special meeting of the stockholders shall be called to elect such number of directors as may be necessary to restore the board to its normal membership. 285. Meetings The frequency of regular meetings of the board is to be decided by the particular conditions. Monthly meetings are usual, but in close corporations with a small board it is often unnecessary to meet regularly more than once in each quarter, or even once each year. In case of any emergency requiring action, a special meeting of a small board can be quickly and easily called. 6 /n re Griffing Iron Co., 63 N. J. L. 168, 357 (1899). 240 CORPORATE LAW [Bk. I- The by-laws should provide the time and place of regular meetings of the board, and should make provision for calling special meetings. The nature and formalities of the call neces- sary to summon a special meeting of the board are purely matters for the corporation to determine. Usually the president is given authority to call such meetings at his discretion. Gen- erally it is provided also that such meeting shall be called upon written request of a certain number usually two-thirds of the directors. More rarely it is provided that a special meeting shall be called upon the written request of a certain proportion in Interest of the stockholders. Where the board is small, it is customary and advisable to provide that meetings may be held at any time and place and without previous notice, by the unanimous consent or unanimous participation of the board membership. Such a provision would usually be useless if the board were large. The place of meeting should be fixed by the by-laws, though a proviso may be added that special meetings may be held else- where by unanimous consent of the board. The office of the corporation is the proper place for directors' meetings and they should be held there unless otherwise agreed by all the directors, To allow a majority of the board to call meetings in private offices, or in places difficult of access, or to permit of adjourn- ment to such places, except by unanimous agreement, is to invite the gravest abuses. 7 286. Notice of Meetings It is supposed that members of the board are familiar with the date of regular meetings. Hence, there is not the same legal necessity for notice that exists in the case of special meet- ings. It is usual though, as a matter of convenience and to prevent such meetings from being overlooked, to provide that notice of regular meetings shall be given by the secretary, and ' See J 420. Ch. 31] BY-LAWS BOARD OF DIRECTORS 241 where specially important action is to be taken at any such meeting, notice of this is also usually given. In the more com- prehensive sets of by-laws it is customary to add a proviso that failure to give such notice shall not affect the validity of the meeting or of any proceedings thereof. It is not probable that the proceedings of a regular meeting of directors would in any case be invalidated on account of failure to give notice^ but the proviso is added out of abundant caution. Special meetings, unless assembled with adequate notice, are 'not legally called and their action may be set aside. Re- quirements as to notice may, however, be waived and special meetings be held without notice by unanimous consent or with the participation of all the directors. Business of any kind may be transacted at any meeting if all the directors have given writ- ten consent thereto or are participating in the proceedings and do not object. Notices of special meetings of directors are usually sent by either mail or telegraph such reasonable time before the meeting as will, under ordinary conditions, permit the attendance of all the members of the board. The by-laws should prescribe the conditions of such notice. If it is desirable to notify directors of meetings by telephone, a provision authorizing such notice should be given in the by-laws. Otherwise, if anyone objected, such notice would not be legally sufficient. The by-laws also usually reiterate the common law rule that no business except that specifically notified in the call and notice shall be considered or acted upon at special meetings. 287. Quorum If the statutes are silent as to the number of directors requisite for a quorum, the charter or by-laws will control. If the statutes and also the charter and by-laws are silent, the common law con- trols and a majority of the full membership of the board is then requisite for a quorum. 'But see Trendley v. Illinois Traction Co., 145 S. W. (Mo.) I 242 CORPORATE LAW [Bk. 1- If the matter is regulated by the by-laws, any desired number may be designated a quorum even though this number may be much less than a majority of the board. It is customary and advisable, however, to require a majority of the entire board to constitute a quorum. Under such provision any reduction in the membership of the board by death, removal, or resignation would not affect the number requisite to a quorum, which still remains the same. 9 The by-law should be carefully worded to avoid any misunderstanding' on this or other points. Directors, on the principle of delegatus non delegare (power delegated to one cannot by him be passed on to another), can- not appear at directors' meeting by proxy. However, as a mat- ter of general law and to prevent misunderstandings and dis- sension, a statement might be included in this by-law that directors cannot be represented by proxies. 288. Election of Officers The by-laws should designate the officials of the corporation, the time of their election, and the period for which they are elected. It is also usual to provide that they shall hold office until the election and qualification of their successors, unless sooner removed by action of the board. It is also usually speci- fied that election shall be by ballot, and that the board shall fix the compensation of officers and fill any vacancies that may occur among them. In arranging the respective dates of the stockholders' annual meeting at which the directors are elected, and the meeting of the directors thereafter at which the officers are usually elected, the latter meeting should not succeed the former so closely as to give inadequate time for the notification of newly elected directors. Frequently such directors' meeting will be arranged to follow the stockholders' meeting on the same day, but a few hours elapsing between the two meetings. ' If the board be small and any possible new members readily accessible, or Erie R. R. Co. v. City of Buffalo, 180 N. Y. 192, 197 (1904). Ch. 31] BY-LAWS BOARD OF DIRECTORS 243 if the entire membership be re-elected, the juxtaposition of the two meetings is immaterial. Where, however, these conditions do not exist, it may occur that some newly elected member of the board fails to receive notice of his election and of the subse- quent directors' meeting in time to permit of his attendance. This might prevent the election of officers or invalidate it if held. For this reason the board meeting for the election of officers should as a rule be fixed at such date subsequent to the annual meeting as will give full time for the regular by-law notice of the board meeting. It is customary and entirely proper to provide that the elec- tion of officers shall follow the election of the board with reason- able closeness, in order that the new board may without delay elect its own corps of officers. 289. Removal of Officers Speaking generally, if an officer is elected for a specified term he cannot be legally removed except for sufficient cause, and not then until he has had opportunity to appear in his own behalf. In a few states the power to remove officers at pleasure is given the directors by statute. Otherwise, if it is desired that the directors shall have the power of removal, it should be clearly conferred on them by the by-laws. The by-law giving the power should be explicit, and to be effective should provide for removal at pleasure with or without cause. If such power of removal is given the directors by the by-laws, each officer accepts his office subject to this regulation, knows upon what tenure he holds it, and may thereafter be removed at the pleasure of the board by a mere majority resolution. i 290. Compensation of Directors T^ i i r ^ - Directors cannot claim any salary or compensation for their services as directors other than is expressly set forth in the by- i See 8312; Douglass v. Merchants Ins. Co., 118 N. Y. 484 (1890). 244 CORPORATE LAW [Bk. I- laws. 11 Definite salaries might be fixed, but compensation is usually provided in the form of a certain stipend for attendance at meetings. The amounts paid for attendance at meetings vary, rarely falling below $5 or exceeding $25. Sometimes a certain fixed sum is appropriated for each meeting and is divided among the directors present. The whole matter is one that rests entirely in the discretion of the stockholders. 12 291. Power to Pass By-Laws i In many of the states the directors are, by statute, given extensive powers over the by-laws. Elsewhere it is a matter for charter or by-law regulation. It is doubtful whether it is wise in -any case to allow the directors full power as may be done by charter provision in New Jersey to override by-laws passed by the stockholders. The only direct control of the stock- holders over the affairs of the corporation is exercised through the by-laws, and if the directors can repeal and abrogate these by-laws at will, they are practically unrestrained in their man- agement of the corporate affairs. At times it is undoubtedly advantageous for the board to have some power over the by-laws in order to provide for matters or emergencies not foreseen by the stockholders. All necessary power in this direction is, however, given when the board is allowed to pass by-laws in harmony, or not inconsistent, with those passed by the stockholders. Anything further is dangerous and susceptible of abuse. 13 292. Order of Business The order of business at directors' meetings is a purely formal regulation included in the by-laws as a matter of convenience. Although.incorporated in the by-laws, it is not mandatory, and any item may be passed, or the entire regular order of business may be suspended or varied at the pleasure of the board. 11 Godley v. Crandall & Godley Co., 212 N. Y. 121, 131 (1914). "See } 311. , "See 231, 253. CHAPTER XXXII BY-LAWSSTANDING COMMITTEES 293. Purpose In most of the larger corporations the board of directors is composed of many members. These are usually busy men, sometimes living in different parts of the country, and almost always difficult to assemble. Many of them are on the board for the sole purpose of representing special interests, and with- out peculiar qualifications or ability for the conduct of the par- ticular corporate business. Under such circumstances the board is not an efficient instrument for the direction of the corporate affairs, and something better adapted to the purpose is neces- sary. The standing committee fills this need, replacing the slow, cumbrous, and uncertain action of a large board with the prompt and effective action of a small selected committee. 294. Power of the Board to Delegate Authority to Committees The courts are clear as to the power of the board to delegate its authority in this manner: The directors convened as a board are the primary possessors of all the powers which the charter confers, and like private prin- cipals they may delegate to agents of their own appointment the performance of any acts which they themselves can perform. The recognition of this principle is absolutely necessary in the affairs of every corporation whose powers are vested in a board of directors. 1 If the defendant can be deemed a business corporation there can be no question but its board of managers would have power to appoint an executive committee of their own number to transact 1 Manson v. Curtis, 223 N. Y. 322 (1918); Hoyt v. Thompson's Express, 19 N. Y. 207 (1859). 245 246 CORPORATE LAW [Bk. I- the business of the corporation during the interval of meetings of the board. 2 295. The Usual Standing Committees Standing committees are permanent committees of the board of directors as opposed to committees of the board appointed for temporary purposes. The membership of such committees is seldom less than three nor more than five. To increase this membership too greatly would involve the very ills the commit- tees were created to avoid. As many standing committees may be appointed as the con- ditions demand. In many cases the executive committee alone is found sufficient. In others a finance committee is added. It is but seldom that other standing committees are necessary. If the executive committee is the only standing committee, it is usually given all the powers of the board in the interim between board meetings, and becomes the active agent by whom these powers are exercised. If there is a finance committee, such matters as come within its purview will be reserved from the powers of the executive committee, and the two committees will then between them exercise all the powers of the board. In such case the executive committee usually controls in all general matters, while the powers of the finance committee are confined to the management and supervision of the corporate finances. These standing committees, appointed with such powers, are the real managing bodies of the corporation, the board merely supervising their operations. They usually act and then report their action to the board. In some cases where they prefer to throw responsibility upon the board, or where some statute provision requires action of the board, or when it is desirable to lend added weight to a contemplated measure, they will report the matter to the board with a recommendation that the desired action be taken. ' First National Bank v. Commercial Travellers' Association, 108 App. Div. (N. Y.) 81 Ch. 32] BY-LAWSSTANDING COMMITTEES 247 296. Misuse of Standing Committees It is to be noted that sometimes an executive committee is provided when the board itself is sufficiently small to permit of prompt action and proper attention to the corporate business. In such case the committee may become of real injury to the corporate interests, the few members composing it managing the entire business of the corporation to the practical and im- proper exclusion of the board. In such cases the directors, as a body, usually lose interest, board meetings are neglected, and the executive committee controls without supervision. In this same general direction is to be found the only danger to be apprehended from the employment of the standing com- mittee: the possibility that it may be used as a convenient means for the elimination of the board or certain elements of the board from control of the corporate affairs, the real man- agement of the corporation being placed in the hands of the selected few who constitute the committees. This danger can be avoided only by careful definition and judicious regulation of the powers of these committees, this to be done in the charter or by-law provisions by which they are created. 3 297. Appointment The standing committees are usually created and empowered, and the manner of appointing or electing their members pre- scribed, by charter or by-law provisions. Since the powers of the board are to a greater or less degree to be delegated to these committees, they must be composed of members of the board. The provisions as to the appointment of members are therefore confined to the manner of their selection from this body. Some- times the creating provision will provide that certain officials of the board shall constitute the standing committees, as for instance that the president, vice-president, and treasurer shall constitute the executive committee. Generally the treasurer is designated as a member of the finance committee. Also it is 3 See 3 Cook on Corp., { 715. 248 CORPORATE LAW [Bk. I- quite usual to provide that the president of the company shall ex officio be a member of the executive committee, and some- times it is provided that he shall be a member and the presiding officer of all standing committees. At times it is provided that the president shall appoint the different standing committees. The most common, and perhaps the safest, plan leaves the mem- bership of these committees to be decided by an election in the board. If there is any danger of the committees being used as a device to exclude minority interests from management of the corporate affairs, the charter or by-laws may prescribe such majority vote of the board for the election of their members as to require the aid of the minority to elect. A provision of this kind might result in a deadlock, but in that case the board would continue in the direct management of the corporate interests until some agreement was reached and acceptable standing committees elected. There is no general rule as to the appointment or selection of officers for the standing committees. In some cases they are designated by the creating provisions, in others they are elected by the board, while in many cases the selection of officers is left to be decided by each committee for itself. It is probably simplest and most satisfactory to provide that the chairman of each committee shall be designated by the board. The only other necessary officer is the secretary. At times it is provided that the secretary of the corporation shall also act as secretary of the committees. If, however, there is more than one standing committee, and especially if these committees are active, it may be found advantageous for each committee to have a distinct recording official who may or may not be a member of that committee. 298. Composition The membership of the standing committees must be .con- fined to the membership of the board, otherwise the power of Ch. 32] BY-LAWSSTANDING COMMITTEES 249 the board to delegate its authority to the committees would be more than questionable, and the action of such committees be of doubtful legality, Within this limitation, the standing committees should be formed on the principles of specialization. Those most familiar with the corporate business and most capable in its practical management will naturally be grouped as the executive commit- tee. Those of most skill and standing in financial matters will properly be selected for the membership of the finance commit- tee. Other considerations frequently intervene to prevent this ideal formation of the standing committees, but the nearer it is attained the better will be the results. The creating provisions not uncommonly provide that the president, vice-president, and treasurer, with or without addi- tional members, shall constitute the executive committee. These officers being elected by the board to the positions they already occupy, are presumably men of executive ability, familiar with the corporate affairs and therefore peculiarly qualified to act as members of the managing committee. On the other hand, such appointment adds materially to the responsibility, the power, and the importance of these officials and may for that reason at times be inadvisable. The treasurer should obviously be a member of the finance committee unless special reasons to the contrary exist. If a member of the finance committee, he should not ordinarily also act on the executive committee. 299. Powers There is no doubt that the board may legally delegate its authority to properly constituted standing committees. 4 This delegated authority may be coextensive with the powers of the board in the interim between board meetings, or may be limited to certain specified actions or lines of action. It has been held 4 The Sheridan El. L. Co. v. The Chatham Nat. Bank, 127 N. Y. 517 (1891); Kavanagh v. Gould, 147 App. Div. (N. Y.) 281 (1911). 250 CORPORATE LAW . /.,[. [Bk. I- that the "full powers" of the board in the interim between board meetings are limited to conducting the ordinary business opera- tions of the corporation. 5 The extent of the power to be dele- gated to the standing committees is usually fixed by the charter or by-law provisions by which the committees are created, though it may be left to be determined by the board itself. If the powers of the standing committees are fixed by the creating provisions, the board cannot delegate powers in excess of those prescribed. The creating provisions frequently go into detail as to the powers and duties of such committees. These powers should be carefully defined, and, speaking generally, should not be too extended. Standing committees should be required to keep full and adequate written records of their proceedings, and these records should be open to inspection by members of the board. Frequent reports to the board are desirable. Properly constituted and empowered, and within the limits of their authority, standing committees act with the same binding force and effect as the board itself. Their contracts are not affected by any subsequent disapproval of the board, nor can the corporation refuse to carry out any of their proper undertakings. 300. Procedure The standing committees act as do other parliamentary bodies. Their usual officers are a chairman and secretary, and these officers perform the customary duties. Regular meeting may be provided for by the by-laws with full provision as to their conduct and record, or the matter may be left to the com- mittees. Owing to their compactness and the manner in which they are constituted, the standing committees are easily assem- bled and a large portion of the business of such committees is usually accomplished in special meetings, either regularly called or assembled by unanimous consent. * Hayes v. Canada, etc., S. S. Co., 181 Fed. 289 (1910). Ch. 3 2] BY-LAWSSTANDING COMMITTEES 251 All special meetings should be duly notified to the members and in the case of "consent meetings" the consent or participa- tion of every member must be secured. If it is desirable to notify members of meetings by telephone, a provision authoriz- ing such notice should be made. part of the by-laws. Otherwise, if anyone objected, such notice would not be legally sufficient. All decisions reached and action taken should be expressed in duly adopted resolutions, and minutes should be kept contain- ing a faithful record of all committee proceedings. These pro- ceedings should from time to time be reported to the board, either by direct report or by the reading of the committee minutes. Vacancies in the committees should be filled as pre- scribed by the by-laws, usually either by the committee itself or by action of the board, except in the case of an ex officio member, who succeeds to his position on the committee by virtue of his election to official position in the corporation with- out further formality, DViiri vjwoq xaiJjjm-wjr.l 301. Quorum of Standing Committee A majority of a standing committee, unless otherwise ex- pressly provided, constitutes a quorum, and in case of a vote a majority of that quorum would decide the question. 6 It may be prudent on this account to provide that the affirmative vote of a majority of the whole committee shall be necessary for action. This does not necessitate any increase in the number necessary to a quorum, but if a mere common law quorum be present the affirmative vote of all the members present would be required to secure action. A standing committee cannot delegate its legislative power to one or more of its members, but must act as a body. J Young v. Canada, etc , Co., 97 N. E. (Mass.) 1098 (1912). CHAPTER XXXIII BY-LAWS OFFICERS Jmhifb.H viUj'^-ji >.i *<*; uh>i> -.] } \^.. .;. 302. The Corporate Officers The term "officers" is here applied to those agents of the cor- poration appointed or elected usually by the board of directors as the direct executive representatives of the board and of the corporation. The directors are themselves at times styled officers, and with legal correctness, 1 but to avoid confusion the directors are not designated as officers in the present volume. In regard to the corporate officers and their duties the statutes are usually silent, the charter seldom takes cognizance of anything pertaining to them, and the by-laws therefore con- trol. Under these circumstances the stockholders as the by- law-making power have wide discretion. They fix the number, titles, qualifications, duties, method of election, and all other details relating to the officers, and their wishes as expressed in the by-laws prevail. If not covered in the by-laws, such mat- ters are regulated by common or parliamentary law or custom, or, as to some of these matters, are determined by the directors. The necessary officers of a corporation are the president, secretary, and treasurer. In- the smaller corporations two of these offices are sometimes held by one person. In most cases, however, the number of officers is increased, according to the needs of the particular corporation, by the addition of one or more vice-presidents, a managing director or general manager, a chairman of the board, counsel, and an auditor. The officials named are for the most part elective, and, with the occasional exception of the general manager, are supposed to report directly to the board or to one of the standing committees. The general 1 i Cook on Corp., { 10. 252 Ch. 33] BY-LAWS OFFICERS 253 manager in some corporations reports to the president or other designated official. Outside of the executive officials, other agents and employees are not officers, and but seldom come in contact with the board. The election of officers naturally follows closely on the elec- tion of directors, and is usually held as soon thereafter as the newly elected board can be properly assembled. The president and vice-president are chosen from the board itself, as they may be called upon to preside at its meetings. This is not necessary in regard to the other officers, though the treasurer is frequently chosen from the membership of the board, and other officials are so selected when convenient. The treasurer of the larger corporations is usually selected on the basis of his financial standing or ability. It would seem obvious that the corporate officials should all have special qualifications and a knowledge of the duties of their positions, though other considerations frequently prevail. 303. Presiding Officers The president is the usual presiding officer. His duties vary widely according to the size and character of the corporation. In the smaller corporations he is frequently assigned the active management of the business in addition to the duties more strictly pertaining to his office. In the larger corporations the duties incident to the president's office are frequently allotted in greater or less degree to other officers. If a chairman of the board exists, that official presides at all meetings of the board. If there is a chairman of the finance committee, he takes over the supervision and direction of the financial matters usually assigned to the president. At times certain of the duties ordi- narily pertaining to the president are performed by the vice- presidents. When the office of chairman of the board exists, its duties should be clearly defined by the by-laws. As the chairman of the board presides at meetings of the board, the general rule 254 CORPORATE LAW [Bk. I- that the president must be a member of the board is not so imperative when a chairman is provided. Even in such case, however, if the president is to be the chief executive of the company, he must almost of necessity be present at meetings of the directors, participate in their discussions and deliberations, and should therefore be a member of the board. Vice-presidents, designated and ranked as first, second, third, and so on, may be provided for in accordance with the corporate needs. These perform the duties of the president in the absence of that official, or of the ranking official, in the order of prece- dence. In addition, in the larger corporations active functions are usually provided for several of the vice-presidents. Frequently their number is swelled merely to afford honorary positions for members of the board. Heads of departments are sometimes made vice-presidents as a "broadening" measure, tending to avoid the friction and the jealousies that so often exist between departments. In the smaller corporations, the duties of the vice-president are sometimes assigned to the treasurer, or this latter is elected as vice-president and treasurer. The presiding officers of the standing committees are usually provided for either by the by-laws or by action of the board, but are sometimes left for the committees to elect. The presi- dent of the company is usually president of the executive com- mittee; the treasurer is frequently placed at the head of the finance committee. 304. Secretary The duties of the secretary should be fully and explicitly prescribed in the by-laws, especially as to signatures. He would naturally have charge of the corporate seal and affix and attest it when necessary, though the president is occasionally author- ized thereto as well. Unless the statutes call for the signatures of the president and treasurer to stock certificates, the secretary is commonly designated to sign such certificates with the presi- dent. He generally has entire charge of the details of the issue Ch. 33] BY-LAWS OFFICERS 255 and recording of stock. The corporate records are entrusted to him, and the various state reports are usually prepared by him. His powers and duties as to signing contracts are entirely dependent upon the by-laws or conditions of the particular cor- poration. Usually he signs with the president, but frequently the president signs alone or with the treasurer, or the matter is decided in each important instance by resolution of the board. When the secretary's signature is not affixed to sealed contracts, it should appear on such instrument in attestation of the seal. 305. Treasurer The treasurer is usually given full charge of the corporate finances and all that immediately relates thereto; also the cus- tody of all corporate instruments and evidences of value. He signs all checks, with or without the president as the by-laws or directors may prescribe, and participates in the execution of all instruments pertaining to the financial transactions of the corporation. The by-laws should clearly define the extent of the treasurer's powers and responsibilities. Whenever the treasurer's position involves the handling or possession of large sums of m9ney, or of considerable property values, he should be required to give bond. In a small corpora- tion, or one where the responsibilities of the treasurer are light, such requirement is an unnecessary formality. The finance committee, if such a committee exists, takes on itself many of the duties and responsibilities of the treasurer, and, unless that official is chairman of the finance committee, renders his position much less onerous, 306. Managing Officers The position of managing director is found only in the larger corporations, and the position and duties of this official are often somewhat indeterminate. In some cases his duties are practi- cally those of the general manager; in others he is given much of the power and many of the duties of the president. At times 256 CORPORATE LAW [Bk.I- the position is in the nature of a compromise, the duties of the managing director being carved from those of the president and general manager. The position of managing director is supposed to be more dignified than that of the general manager. Its duties should be clearly prescribed by the by-laws in order to prevent possible conflicts of authority. This is the more necessary, as the duties of the position are not so definite or so well understood as those of the other officials, and custom cannot be referred to for missing details. The general manager is accounted an officer of the company in contradistinction to the employees only because he is selected by and usually reports to the board. His position generally differs materially from that of the other officials. At times he is instructed to report and act under the direction of the president, and if the by-laws did not specifically provide for the election of a general manager the directors would have authority to appoint or employ such official and prescribe his duties and salary, just as they might employ any other neces- sary agent or employee of the company. In such case the usual laws and customs relating to his employment would control. 307. Counsel In the larger corporations an attorney is usually retained as a regular and permanent feature of the management. Such official has no original powers, even his control of litigation being subject to the direction of the board, or, if it be so referred, to one of the standing committees. In the smaller corporations by-law provision for counsel is not usual, the board being left to employ legal assistance at such times and on such terms as it may deem expedient. The employment of counsel then becomes merely a matter of con- tract. The compensation of counsel, when regularly retained, is usually fixed at some minimum amount, which is considered a Ch. 33] BY-LAWS OFFICERS 257 retainer, any further payments depending upon the services rendered. 308. Auditor The auditor is usually an essential officer of the larger corporations : This officer has charge of all matters pertaining to the keeping of the financial records. He plans books of account, devises methods of recording and accounting best calculated to fulfil the purpose of the company, and watches over the faithful recording of all facts. He submits, at stated periods, statements showing the financial status of the enterprise and the causes which have con- tributed to its success or to its failure. 2 Where the work that may properly be referred to the auditor is not sufficient to justify his regular employment, the by-laws may provide for periodical audits, or the whole matter may be left to the discretion of the board. Where the volume of cor- porate business is at all large, the employment of an auditor or some provision for suitable audits of the corporate books and accounts is a usual and advisable precaution. 309. Assistant Officers The president is usually well provided with assistants in the vice-presidents. An assistant treasurer is not unusual. In the larger corporations an assistant secretary also is frequently appointed. Such official duties as the board may deem expedient are delegated to these assistant officers, or their duties may be prescribed at discretion by the officials they assist. In any event, the by-laws should clearly prescribe their status and manner of appointment. If these assistant officers are to per- form the duties of their principals in the absence of these latter, the by-laws should so prescribe. ' Esquerrfi on Applied Theory of Accounts. 258 CORPORATE LAW [Bk. I- In the smaller corporations assistant officers, outside of the vice-presidents, are an unnecessary and possibly complicating addition to the corporate mechanism. 310. Delegation of Official Powers Exigencies may arise in which it may be desirable or even necessary for one corporate official to exercise the powers and perform the duties of another, in whole or in part! The board would have authority to delegate temporarily the powers of certain officers under such circumstances without special by- law provision, but, to save question and possible trouble, the power, if likely to be necessary, should be specifically conferred by the by-laws. One official cannot delegate his powers to another, even temporarily, in any material matter, unless spe- cially authorized thereto by the by-laws or action of the board. 311. Salaries Unless it is specified that officers are to receive salaries, they are not as a rule entitled to charge for their official services. 3 Neither is it ordinarily legal for the directors to vote compen- sation for such official services after they are performed. 4 To avoid misunderstanding, however, the conditions, whatever they may be, should be clearly stated in the by-laws that the officers of the corporation shall receive no salaries, ^or that the officers shall receive only such compensation for their services as the board may designate at the time of their appointment, or that the officers shall receive the specified salaries, stated in the by-laws. The whole matter is one to be adjusted from a busi- ness standpoint and much trouble is likely to be saved by a definite arrangement. 5 If, however, such an officer is neither stockholder nor director of the company and stands in no relation which would make it 3 Hayes v. Canada, etc., S. S. Co., 181 Fed. 289 (1910). 4 Lewis v. Matthews, 161 App. Div. (N. Y.) 107 (1914); Ellis v. Ward, 137 111. 509 (1890). 6 See Henry Woods Sons' Co. v. Schaefer, 173 Mass. 443 (1899); Met. El. R. Co. v. Kneeland, 120 N. Y. 134 (1890). Ch. 33] BY-LAWS OFFICERS 259 his interest to serve without compensation, there will be a prima facie obligation to pay him. 6 Officers who are also directors cannot vote salaries to them- selves even though they are also holders of a majority of the stock. 7 But an officer who is also a stockholder and director may recover for services rendered outside his official duties if such services are authorized by the directors. 8 312. Removals; Vacancies The power to remove officers and to fill vacancies among them, when given the directors, is usually provided for in the by-laws under the head of "Directors." 9 It would be proper, however, to repeat any powers given the board in this direction, in a short by-law under the heading of officers, or the ground might be covered by a reference to the by-law by which this power was conferred.. If the occasion arises for the exercise of the power of removal, or it becomes necessary to fill a vacancy, there should be no possible basis for any doubt or question as to the authority of the board to act. 6 Smith v. Long Island R. R. Co., 102 N. Y. 190 (1886). 7 Jacobson v. B. Lumber Co., 184 N. Y. 152 (1906); Davids v. Davids, 135 App. Div. (N. Y.) 206 (1909). 8 Bagby v. Carthage, etc., Co., 165 N. Y. 179 (1900); Corinne Mill Co. v. Toponce, 132 U. S. 405 (1893). See also 189. See { 289. CHAPTER XXXIV BY-LAWS DIVIDENDS AND FINANCE; SUNDRY PROVISIONS 313. Financial Provisions All those by-law provisions directly relating to the financial management of the corporation are usually grouped under the general heading of "Dividends and Finance." Any desired limitations on the control exercised by the directors over the finances of the corporation, and any directions as to the man- agement of these finances, must, unless incorporated in the charter, appear in the by-laws. Otherwise the directors are in complete control, except as restrained by. statute law. It is to be noted that any restrictions on the salaries of officials, if of a general nature, should appear in the by-laws relating to finance. If the amount of each official salary were fixed, such limitations might appear under "Dividends and Finance," but would also be included in the by-laws relating to the officers affected. 314. Dividends By-law provisions as to dividends are for the most part merely declaratory of the common or statutory law on the sub- ject. Their inclusion in the by-laws is very desirable, not only on account of the importance of the matter, but because the statutory or common law provisions against illegal dividends are otherwise frequently overlooked or disregarded. 315. Reserve Funds In most of the states the directors have full power, unless otherwise provided by charter or by-laws, to set aside any por- 260 Ch. 34] BY-LAWS DIVIDENDS AND FINANCE 261 tion or all of the corporate profits at their discretion, as a reserve fund or for the purpose of accumulating a working capital. In New Jersey, on the contrary, the directors, unless otherwise expressly authorized by charter or by-laws, must annually dis- tribute all the corporate profits as dividends. Such compulsory distribution of profits might at times be prejudicial and even disastrous to the corporate interests, and accordingly it is usual in New Jersey to authorize the accumulation of a reserve fund by charter or by-law provision. In other states the matter of reserves is sometimes left entirely to the discretion of the directors, but is usually regu- lated by suitable provisions in the by-laws. The minimum re- serve fund to be maintained will be prescribed, in which case no dividends must be paid while the reserves are below this minimum; or a stipulated annual dividend will be required from the annual profits before anything is passed to the reserve ; or a certain percentage of the annual profits will be passed to the reserve fund. Whatever the arrangement it should be so clearly expressed as to admit of no misunderstanding. 316. Limitations on Power to Incur Debt By-law restrictions upon the power of the directors to incur debts are not uncommon. These limitations are of various forms. At times the debt-incurring power of the board will be limited to a stated gross amount which must not be exceeded without special authorization by the stockholders; 'or it may be provided that such limit of indebtedness shall not be exceeded unless authorized by a specified 'majority of the directors, as a two-thirds vote of the entire board, or perhaps by unanimous action of that body. Occasionally the board will be restricted as to the amount of any one contract or obligation, as for in- stance that no contract or obligation involving liabilities of more than $10,000 shall be entered into or incurred by the board unless specifically authorized thereto by resolution of the stock- holders. 262 CORPORATE LAW [Bk. I- The advisability of such limitations is open to question. Peculiar cases will undoubtedly arise where such restrictions are desirable, and at times they are necessary, but as a general rule it would seem better to elect a responsible board rather than to attempt to place restraints upon its action. 317. Bank Deposits The by-law provisions as to the corporate bank deposits are important and should be very explicit in their terms. They should prohibit absolutely any irregular retention or disposition of the funds by the treasurer, and provide that all moneys coming into his hands be promptly deposited in the name of the company. This latter point should be covered specifically and clearly by the by-laws, as the practice of allowing deposits to be made in the individual name of the treasurer, or in his name as treasurer, is a standing invitation to irregularities and re- sulting trouble. The by-laws should also prescribe the signature to corporate checks. Practice varies as to this matter but as it saves time and trouble to have checks signed with but one signature, it is usually preferable for the smaller corporation. The treasurer may be the only person authorized to sign checks, but to avoid inconvenience when he is absent, it is better to have the presi- dent or some other responsible officer also authorized to sign. It is a common enough practice to require two signatures to all checks, but where many small checks are to be signed, one of the persons is almost sure to sign mechanically, trusting to the other, or in case of abse'nce or vacation to sign or coun- tersign a number ahead and this nullifies any possible advan- tage from the rule. In the case of the larger corporations the usual custom is to have all important checks signed by two officials, and in the absence of either, some other official is deputed to sign, so that every check of material amount is signed by two officials. In all such cases there would probably be also something in the Ch. 34] BY-LAWS DIVIDENDS AND FINANCE 263 nature of a current expense account to take care of the smaller items, and the checks against this would require but one signa- ture. In any case, if one person makes out the body of the check, and the signature is by another, nearly all of the practical advantage of two signatures is secured. The by-laws relating to bank deposits should cover the ground fully and clearly, leaving nothing to the discretion of the board or finance committee save the designation of the depositaries. SUNDRY PROVISIONS 318. General Under this head will come all those by-laws that cannot be included under the titles already discussed and that are too few or unimportant to justify separate classification. Some of these matters are of particular application. A few of general application are found in all complete sets of by-laws and are considered in the following sections of the present chapter. 319. Corporate Seal It is customary to prescribe the details of the corporate seal in the by-laws, the provision being usually so worded as to serve as a formal adoption of the described seal. This seal usually gives the corporate name, the year, and the state of incorporation. These are customary, but unless prescribed by statute are not essential, as any other wording or device, if properly adopted, would be the legal seal of the corporation. Any additional designs, mottoes, or ornamentation may fte added as desired and will neither add to, nor detract from, the legal effectiveness of the seal. 320. Penalties The enforcement of by-laws by means of penalties is of doubtful utility. Cases may arise where penalties may be 264 CORPORATE LAW ytf [Bk. I- profitably employed, but usually such measures are futile and inadequate. Where the power of removal exists, persistent disregard of the by-laws by officials of the corporation would undoubtedly be proper grounds for the exercise of this power. If such power is not given by the by-laws or statutes, official disregard of the by-laws would probably be sufficient reason for a removal on common law grounds. If the directors act in dis- regard of the requirements of the by-laws, such action is illegal, and the personal liability that may follow is a much more effec- tive penalty than anything that could be inflicted by direct by-law provision. 321. Amendments The usual by-law provisions on this subject require majority action of the stockholders for amendment of the by-laws. This conforms to the provisions of the common law. Where greater stability is desirable on account of special provisions incor- porated in the by-laws, or generally as a protection to minority interests, it is sometimes provided that two-thirds in interest, or even a larger proportion of the stockholders, must vote in favor of any amendment before it is effected. Such provisions, merely made part of the by-laws, unless reinforced in some way are of but little avail. The majority have the right to amend and repeal the by-laws, and it cannot be taken from them by a mere unsupported by-law inhibition, i 322. By-Laws as Contracts Such a provision, to be effective, must either be incorporated in the charter, or, if in the by-laws only, must be so established and confirmed by vested rights accrued under it as to have become in effect a contract between the corporation and the Stockholders. When this is done the by-law becomes unchange- 1 Smith v. Nelson, 18 Vt. 511 (1846); Manufacturing Bldg. Co., v. Landay, 219 111. 168 fipos). Ch. 34] BY-LAWSSUNDRY PROVISIONS 265 able, except in accordance with its own provisions. As stated in a noted New York case: 2 "A private corporation cannot repeal a by-law so as to impair rights which have been given and become vested by virtue of the by-law; and this although the power is reserved by its charter to alter, amend, or repeal its by-laws." This is stated yet more strongly in a New Jersey case,s a case where stock had been sold on the strength of the safety afforded by special charter and by-law provision, and the court states the settled law to be: That the certificate of organization and the by-laws contem- poraneously adopted, constitute a contract between the stock- holders, and that it is not competent for the legislature to authorize either to be changed without the consent of all the stockholders, except it be done in the mode provided by the by-laws themselves. It is worthy of note that it has been decided in Pennsylvania that the by-laws cannot be amended by a majority of the stockholders at an annual meeting in any important particular, such as an increase of directors, unless the notice of that meet- ing informed all the stockholders that such action was con- templated.* In other states, such notice should be given as may be re- quired by the local statutes, by the charter, or by the by-laws themselves. Usually a regular meeting of stockholders, duly assembled, would have power to act on any business unless the state law, the charter, or the by-laws prescribed otherwise. 1 The New York Court of Appeals in Kent v. Quicksilver Mining Co., 78 N. Y. 159 (1897). Loewenthal v. Rubber Reclaiming Co., 52 N. J. Eq. 440, 441 (1894); see also Mills v. Cent. R. R. Co., 41 N. J. Eq. ,i (1886). Bagley v. Reno, etc., Co..''2Oi Pa. St. 78 (1902). Part VII Organization Meetings CHAPTER XXXV -.(>! v . FIRST MEETING OF STOCKHOLDERS 323. General In the great majority of the states, procedure for the organi- zation of a corporation is uniform as to the main features. First, the charter is prepared and is executed by the incorporators; next, this duly executed charter is filed with the officials pre- scribed by statute; then the meeting of incorporators is held, by-laws adopted, directors elected, and such other action taken as may be necessary. The directors then meet, elect the officers of the corporation, and its organization is complete. In a few states, however, this procedure is practically re- versed, the election of directors and officers and adoption of by-laws preceding the filing of the charter. In other words, the by-laws are adopted and directors and officers elected before the corporation has any legal existence. The arrangement seems somewhat illogical, but is prescr bed by the statutes of certain states and in those states must be followed. It merely amounts to a preliminary determination of these details, of no force unless the charter application is allowed, but then becoming automatically effective and binding on the new corporation. This variation of the usual procedure is found in Maine, Massa- chusetts, and some other states. In these states the proceedings outlined in the present and following chapters must be modified to meet the statute requirements. Under the customary procedure, the duly prepared charter 267 268 CORPORATE LAW [Bk. I- application, accompanied by the proper fees, is submitted to the official designated by the statutes, for approval and filing. After the application has been approved and filed and this has been notified to the incorporators, these latter are authorized to assemble and perfect the organization of the new corporation. 324. Who May Participate The incorporators or their proxies are the only persons entitled to act at this time. Their power to call the first meeting and to act thereat for the corporation is derived from the recognition and express authorization given them by statute. If their sub- scriptions are set forth in the charter itself, each incorporator votes at this first meeting in accordance with such stock sub- scription, one vote for each share subscribed for. In those states where the first meeting is held before the charter is granted, each incorporator is usually entitled to but one vote in the organization meeting. There may be numerous subscribers to the stock of the new corporation who are not named hi the charter, but these sub- scribers are not yet stockholders of the corporation, and do not become stockholders and are not entitled to any participation in its affairs until after express acceptance of their subscriptions by the corporation. Unless there is some good reason to the contrary, the number of incorporators is usually fixed at the minimum allowed by the statutes. This is done purely as a matter of convenience and as simplifying the formalities preliminary and incident to the first meeting. 325. Assembling the Meeting Where the number of incorporators is small, the first meeting is most conveniently assembled by means of a written call and waiver of notice which must be signed by all the incorporators. 1 This call and waiver fixes the time and place of meeting, and 1 See Book IV, Form 90. Ch. 35] FIRST MEETING OF STOCKHOLDERS 269 should also specify the business to be transacted thereat, though, by reason of all the interested parties signing, so much particu- larity is not necessary as in the call for the usual special meeting. A blanket phrase consenting to the transaction of any and all business brought before the meeting is in this case allowable and authoritative. Such a call and waiver, to be effective, must be signed by every incorporator at or before the time of meeting. If it is not, a meeting held pursuant thereto is not legally called and its proceedings are liable to be set aside. 2 The call and waiver need not be issued or signed at any definite time before the meet- ing, as it is a waiver of all statutory requirements of notice. A meeting assembled by means of a duly signed call and waiver, and properly conducted, is legal in any state. Often the call is signed at the meeting as the first order of business. Where for any reason the call and waiver of notice cannot be used, any form or method of procedure prescribed by the statutes for the assembling of the first meeting should be followed to the letter. If no form is prescribed by the statutes it will be necessary for a majority of the incorporators to unite in a call for the first meeting. 3 This call must fix the time, place, and business to be transacted at the meeting, and must be served on the incorporators who have not signed the call. Any convenient place of meeting may be selected, the time of notice must be sufficient to permit all the incorporators to be conveniently present, and the business to be transacted should be set forth in detail. The meeting is practically nothing more than a special meeting of the stockholders, and in the absence of statutory prescription, its notice should follow the general rules in regard to notice for special meetings. 4 326. Preparation of Minutes The first meeting of stockholders, and usually the first meet- ing of the directors as well, is of the cut-and-dried order. In 2 Braintree, etc., Co. v. Braintree, 146 Mass. 482 (1888); Holcombe et al. v. Trenton White City Co., 82 Atl. (N. J.) 618 (1912). 1 See Book IV, Form 90. See }} 268, 270. 270 CORPORATE LAW [Bk. I- most cases the incorporation is undertaken for a specific purpose and usually by certain people, who have already settled among themselves just how the corporation is to be organized in all main details. The organization meetings are merely a formal execution of these prearranged plans. It is therefore customary to have the minutes of these first meetings written out in ad- vance and often with much particularity. 5 The advantages of the plan are found in the orderly procedure thereby outlined, the better presentation of the matters to be considered, and the inclusion of all matters that ought to be considered. If anything occurs at or during the time of the meeting to modify the minutes as already written, the necessary changes are quickly made on the prepared draft by erasure or interlineation, and are properly incorporated in the minutes when these are entered in the minute book. 327. Conduct of First Meetings The manner of conducting the first meetings varies widely with the conditions. In certain cases, where everything is set- tled in advance and is to be kept in the precise shape determined upon, the entire minutes are put in final shape before the time of meeting. Then the attorney, or other party having the in- corporation in hand, after due assembling of the incorporators, reads to them these cut-and-dried minutes as the proceedings of the meeting. With the assent of those present, or in the absence of express objection, the minutes so presented are de- clared to be the minutes of the meeting, which is thereupon adjourned The minutes are then transcribed in the minute book, are signed by the parties respectively mentioned in the minutes as the presiding officer and secretary, and the matter is closed. The directors' meeting is conducted in the same perfunctory manner and with the same precision of result. This method though informal and irregular cannot be said * See Book IV, Form 89. Ch. 35] FIRST MEETING OF STOCKHOLDERS 271 to be illegal. The presence of all the parties in interest and their assent and active participation, act to estop them from objecting to the proceedings and no one else would have the right to object. It is needless to say that when this method is employed the incorporators are frequently dummies, who after the completion of the organization make way for the real parties in interest. When the exact proceedings of the minutes are to be carried out but the attorney in charge does not wish it to be so purely a matter of form, the minutes will be read but the parties named therein will go through the indicated motions. Thus, if the minutes state that the charter is presented by the president, or chairman, a copy of the charter will be handed the party named in the minutes as the presiding officer and the minutes verified by its due presentation to the meeting. Likewise the parties named as making and seconding motions will be asked if they make and second such motions, their ready assent usually veri- fying the predictions of the minutes to a nicety. Also, as each motion is reached in the reading, the meeting will be asked if it favors such motion, the assent of the meeting usually being readily obtained. Such a meeting is less of a legal fiction than the meeting conducted entirely by the reading of the minutes, and is to be preferred. Where the real parties in interest participate in the first meetings, the proceedings are not usually of such a perfunctory nature. The minutes then serve more as a detailed order of business and are varied as the needs of the occasion seem to indicate. The presiding officer really presides, the secretary performs his functions, motions are made, the necessary elec- tions actually take place, discussions are in order if the necessity arises, and, in short, the assemblage is a meeting intelligently acting, and not a collection of dummies, useful mainly as pegs upon which to hang the prescribed proceedings. In the comments which follow, it has been taken for granted that the actions of the meeting are to be really taken. 272 CORPORATE LAW [Bk. I- 328. Opening the First Meeting of Stockholders At the duly appointed time and place, the incorporators or a majority of them, having assembled, some one of those present calls the meeting to order, and, in the absence of objection thereto, calls on some other incorporator present to take the chair. If there is any objection to the appointee, or to the selec- tion of a chairman by appointment, the party calling the meeting to order should let the matter be decided by vote. The chair- man, as soon as his appointment or election is announced, takes charge of the meeting and, if there is no objection thereto, appoints some one present to act as secretary. If there should be any objection to the chairman's appointment of a secretary, it will be necessary to settle the matter by vote. The secretary, as soon as appointed or elected, will note the names of those present and ask for the proxy of any incorporators not present in person. It is always desirable to have all the incorporators represented at this first meeting in person or by proxy, though a majority in interest can legally act if properly assembled. The next step is to show that the meeting has been properly called. This is a matter for the secretary. If it has been assem- bled by call and waiver signed by all the incorporators, this call and waiver should be produced, be given to the secretary if not already in his possession and be ordered entered on the minutes of the meeting. If called by publication, copies of the news- papers in which the notice appeared, or the affidavit of the printer, are adequate evidence. If called by notice served per- sonally or by mail, a copy of the notice should be presented, accompanied by a certificate of the party by whom it was served that such service was duly effected. If the meeting assembled in any other way, the procedure and the evidence should be laid before the meeting and appear in the minutes. 329. Reception of Charter The chairman or secretary should now produce a copy of the certificate of incorporation, and report the fact and date of Ch. 35] FIRST MEETING OF STOCKHOLDERS 273 its allowance, its filing in the office or offices required by the statutes, and the payment of the required fees. It is not essen- tial that this copy of the charter be certified by the secretary of state, though such certified copy is customarily procured and is generally more satisfactory to the interested parties than an uncertified copy. When the charter is presented a motion is in order that the certificate of incorporation as presented be accepted or received and spread upon the minutes as a part of the record of the meeting. The charter is entered preferably on the first pages of the minute book, followed by the by-laws, with the other instruments that are made part of the record following the minutes proper, each beginning at the head of a page. So arranged, these instruments are much more easily found and referred to than if incorporated and buried in the body of the minutes. Also the minutes themselves are clearer and more intelligible if not broken up by the interjection of the lengthy instruments ordered spread upon the minutes. The legal effect of the entry of these instruments in the way indicated is exactly the same as if they appeared in the context. The minutes should, of course, note in the proper place the action on these instruments, and refer to the pages of the minute book on which they are entered. 330. Adoption of By-Laws The by-laws are usually prepared in advance of the first meeting and have been fully considered by those interested. 6 At the time of the meeting, they are presented, read article by article by the secretary or by such other person present as may be designated by the presiding officer, and adopted as a whole. At times each article will be adopted as read, followed by the adoption of the by-laws as a whole, though this is not a necessary formality. See 1257. 274 CORPORATE LAW [Bk. I- If serious objection is offered to any of the by-law provisions, such objection will be taken under consideration by the meeting and any proposed modifications settled by formal action. As the time at this first meeting is, however, usually fully occupied with routine procedure, such matters cannot be given the con- sideration they deserve and any objections or suggestions in regard to the by-laws should be discussed and, if possible, set- tled before the meeting. Where the by-laws have been fully considered by the in- terested parties in advance of the meeting and all are familiar with their provisions, the reading of the by-laws may, either by unanimous consent, or by formal motion, be dispensed with and the by-laws adopted as presented and as a whole. The reading of the by-laws before adoption is, however, the safer plan, preventing disagreement later as to just what was adopted. Usually the resolution by which the by-laws are adopted closes with a clause directing their entry in the book of minutes immediately following the certificate of incorporation, 331. Election of Directors In most of the states the election of directors properly fol- lows the adoption of the by-laws, such election being the only method by which the directors may be properly designated and empowered. In New York and in some other states, how- ever, the directors for the first corporate year are named in the charter. In New York these directors have certain powers as to adoption of by-laws. In such case no action in regard to the directors is necessary at the first stockholders' meeting, and, indeed, the first meeting loses much of its importance, as the board is already in existence with full power to make by-laws and to take up and manage the affairs of the corporation. A prompt first meeting of stockholders is, however, still advisable, as otherwise the board must adopt by-laws of more or less completeness and may be forced to take other action which is better taken by the stockholders. Ch. 35] FIRST MEETING OF STOCKHOLDERS 275 Where directors are to be elected at the incorporators' meet- ing, any statutory directions must be followed exactly and the minutes should show in detail that this has been done. In the absence of statutory provisions, an election by ballot, con- ducted by tellers appointed by the presiding officer, is legal and proper. In such case the meeting is the judge of the qualifica- tions of voters, and each incorporator or other participant votes according to the number of shares of stock subscribed for by him. If an agreement exists as to the parties to be. elected as directors, these parties might be nominated by the meeting, and the secretary by motion be instructed to cast the vote of the meeting for the parties so nominated. 332. Exchange of Stock for Property The board of directors is the proper and final authority to conclude an exchange of stock for property. Where, however, as is often the case, a large proportion or possibly all the stock of the corporation is to be issued in payment for some particular property, it is customary and advisable to have the proposed purchase sanctioned and authorized by express action of the stockholders. Such action if unanimous commits all the stock- holders to the purchase, and estops the participants from later objection to the transaction. The incorporators also usually specifically approve the price at which the property is taken over. This is a desirable precaution. 7 The proposal for exchange of stock for property is usually presented to the meeting, read, discussed if desired, and then a resolution passed approving the proposed purchase, referring it to the directors and instructing them to consummate the same. 8 333. Other Business Usually there will be other business to come before the stockholders at this first meeting, depending upon the condi- 7 McBryan v. Elevator Co., 130 Mich, in (1902). ' See Book IV, Forms 89, 94. 97. 276 CORPORATE LAW [Bk. 1- tions surrounding the particular corporation. In some slates, specific action is required of the stockholders by the statutes. If there is any action to be taken by the directors in which there is doubt of their power, or in which some advantage is to be gained by an authorization from the stockholders,' the necessary action should be taken at this time. Beyond this it is not ad- visable for the stockholders to go. All matters of general man- agement are in the hands of the board, and any uncalled-for action in regard thereto on the part of the stockholders can have no advantageous results and may embarrass the proper action of that body. CHAPTER XXXVI -)(\ vllirruJj fiobmoqiOD FIRST MEETING OF DIRECTORS 334. Calling the Meeting In the majority of the states the directors of a new corpora- tion are elected at the first meeting of stockholders, and, of necessity, the first board meeting is held subsequent thereto. Even in those states where by charter appointment of the board that body might meet in advance of the first meeting of stock- holders, it is the general practice for the meeting of stockholders to come first. At their first meeting the stockholders usually adopt by- laws. The board in its first meeting has therefore the guidance of these by-laws so far as they apply. As the first meeting of the board is not a regular meeting, it is governed by the by-law provisions relating to special meetings, except as variations are made necessary by the unorganized condition of the board at this time. No secretary having as yet been elected, the meeting cannot be called or assembled as it otherwise might, but must be as- sembled by a call signed by a majority of the 'members of the board, such call being in its general form similar to the usual call for special meetings and complying in every way with its requis- ites; 1 or otherwise, and as is usually done, the meeting may be assembled by a written call and waiver of notice signed by every member of the board at or before the time of the meeting.* Signatures affixed after the time of the meeting have been held non-effective.' 'See Book IV, Form 117. } See Book IV, Forms 95, "7- Holcombe et al. v. Trenton White City Co., 82 Atl. (N. J.) 618 (1912). 277 278 CORPORATE LAW [Bk. I- The call, or call and waiver, as the case may be, should specify the time and the place of meeting, and give in detail the various matters to be considered and acted upon. If the stockholders have selected any office or definite headquarters for the new corporation, the meeting of the directors will naturally be called for that place; if not,, any convenient place is proper. Often the office of its attorney is chosen. The most important matters for consideration at this meeting are the election of officers, the issuance of stock for property where this is to be done and the authorization of any proceedings necessary to the commence- ment of business. A blanket provision permitting the trans- action of any and all business pertaining to the affairs of the corporation should be included in the call and waiver. Signed by the entire membership of the board this provision is effectual and permits action on any corporate matters that may come up for consideration. At times this latitude of action is of con- siderable advantage. 335- Minutes As in the case of the stockholders' first meeting, the proceed- ings of the first meeting of directors may usually be anticipated and minutes be prepared in advance with considerable accuracy. Occasionally in such case the minutes are prepared in permanent form and the proceedings conducted in accordance by a mere reading of these minutes their adoption as the minutes of the meeting being signified by silent acquiescence, by express assent, or by a more particularized assent on each important point as the reading progresses. Usually, however, the prepared minutes are used more as memoranda, the meeting going through the motions at least of transacting the outlined business. 4 It is hardly necessary to say, that "cut and dried" minutes should not be prepared or used where there is any probability of a difference of opinion in the board. Courtesy would forbid, See Book IV, Form 94- Ch. 36] FIRST MEETING OF DIRECTORS 279 even if there were a decided majority in favor of the outlined action. Also, speaking generally, it would be neither politic nor advisable to ignore so openly the consideration and delibera- tion which should characterize board action in case of disagree- ment. 336. Opening the First Meeting of Directors When the board assembles in its first meeting it is unorganized and must therefore be called to order by some one of its members, who, on his own volition or at the request of other members, takes the initiative. This member merely calls the meeting to order, and, in the absence of objection, names a temporary chairman or presides until a temporary chairman is appointed or elected by the meeting. This chairman then takes charge, of the meeting, a temporary secretary is at once appointed or elected, and the temporary organization of the board is complete. The call, or call and waiver, or other authorization under which the board has assembled, should then be presented, and if it appears that the meeting has been duly assembled, the evidence thereof should be ordered entered on the minutes. In the absence of objection this might be so ordered by the presiding officer, otherwise by formal action. As the meeting is a special meeting it is important that it shall have been properly called and that due record be made of this fact. A roll call, or its equivalent, the recording of those present by the secretary, completes the opening formalities and the meet- ing is ready for business. 337. Election of Officers If, as is almost invariably the case, the officers of the corpora- tion are to be elected by the board, their election is the first business before the meeting. The by-laws already adopted by the stockholders usually designate the officers to be elected and the manner of their election, and these requirements should be strictly followed. Generally the election is by ballot. Candi- 280 CORPORATE LAW [Bk. I- dates for the various offices might be severally nominated with due second thereto, but when, as is usually the case, all these candidates have been agreed upon in advance, formal nomina- tions are dispensed with and the details of election taken up at once. Where all are agreed, a motion is frequently passed in- structing the secretary to cast the single ballot of the meeting for the recited list of officers. This is proper and at times con- venient. If the 'election is to be carried out in detail, the presiding officer will, in the absence of objection, appoint tellers. The members of the board then prepare their respective ballots and the tellers collect and count these ballots and announce the results. Each officer may be balloted for separately, or, as is usually the case, one ballot be made to serve for all the officers. Immediately after the election the newly elected president and secretary, if present, take charge of the meeting and assume their respective official duties. If, however, these officials-elect are absent, or if anything prevents their immediate assumption of their duties, the temporary officers will continue to act until the close of the meeting, unless the permanent officers sooner take charge. If the secretary is required to be sworn, as in New Jersey, he should comply with this requirement before under- taking to act in his official capacity, though his failure so to do would not vitiate his records, nor affect in any way the legality of the meeting. 338. Adoption of Stock Certificate The stockholders may, if they so desire, either by resolution or by-law provision, adopt a form of stock certificate. The matter is one, however, that is usually and better left to the discretion of the board. Frequently temporary certificates are adopted, to be replaced later by more elaborate permanent certificates. Changes of conditions may occur necessitating change in the certificate originally adopted. Other contingen- Ch. 36] FIRST MEETING OF DIRECTORS 281 cies affecting its form not infrequently arise. For these and other reasons the matter is one best handled by the board. Frequently a form of stock certificate is selected and possibly printed or engraved before the time of the first board meeting. Even if this be so, the selected form should be formally adopted, and either the secretary should be authorized and instructed to procure the necessary books of stock certificates, or if the books have already been procured, such action should be ratified and the books as presented be accepted. The resolution by which this is effected should also authorize the secretary to provide a .seal, minute book, and such other corporate books and stationery as may be required. The form of seal is customarily determined in the by-laws which have already been adopted by the stockholders. If this is not the case the form of seal should be selected and adopted by the directors. 339- Acceptance of Subscriptions Subscriptions made by the incorporators of a new company need no formal acceptance. The mere fact of their having executed the charter, in which their subscriptions usually appear, and of having participated in the organization meetings, obviates the necessity of acceptance. If there are other subscribers to the stock of the new company, these other subscriptions require formal acceptance. This is accomplished by resolution of the board of directors. The acceptance of these subscriptions com- pletes and makes binding the contract between the corporation and those who have offered to take its stock. Neither party can then recede, and the accepted subscribers at once become stock- holders of the corporation, entitled to all the rights of stock- holders. The issue of certificates to these subscribers does not usually take place until their subscriptions are fully paid, but this does not affect their rights as stockholders in any way, the certificate being merely a convenient method of evidencing their See Book IV, Form 94. 282 CORPORATE LAW [Bk. I- status. If "accepted" subscribers do not fulfill the conditions of subscription, their stock may be forfeited when statutory author- ity for such procedure exists, but until such forfeiture takes place their rights are in full existence. 6 The acceptance of subscriptions is followed by such action in regard to the payment thereof as may be necessary. If part or all of the subscription price of the stock were due on acceptance, the treasurer of the company would be empowered to collect the amounts due. If, as in New Jersey, thirty days' call must be made unless waived by the subscribers before any part of the subscription price of stock can be collected, the board should* either instruct the treasurer to issue such call, or, as is usually done, secure a waiver of this condition by the subscribers and take immediate steps for the collection of the amounts then due. If the corporation has been organized with the minimum amount of subscriptions permitted by the statutes and additional subscriptions are necessary or desired, the action taken will be governed entirely by the conditions of the particular corpora- tion. In most cases the proper officers of the corporation would be instructed to offer for sale or subscription such portion of the capital stock as was to be sold. 340. Exchange of Stock for Property If, as is almost invariably the case with business corporations of the present day, all or a portion of the corporate stock is to be issued in exchange for property, the matter is usually brought before the first meeting of the board by the submission of a for- mal written proposition for the exchange, accompanied by a resolution of the stockholders approving the exchange and in- structing the directors to accept the proposition. These matters are presented with proper explanations by the presiding officer, or may with entire propriety come through the secretary. Usually the proposition is ordered received and spread in full i Cook on Corp., Si 52, 72; 2 Ibid., { 540; but see Bole et al. v. Fulton et al., 82 Atl. (Pa.) 947 (1912). Ch. 36] FIRST MEETING OF DIRECTORS 283 upon the minutes of the directors' meeting. If it has already been entered in full in the stockholders' minutes, the entry in the directors' minutes would not be necessary, but preferably the proposition should be reserved to appear in the directors' minutes in connection with the final action taken thereon. Usually such a proposal calls for little discussion as the matter has already been fully considered. The presentation and formal disposal of the documents in the case is therefore generally fol- lowed by a formal resolution of acceptance. This resolution should briefly recite the conditions, specifically accept the propo- sition, and instruct the officers to take the necessary steps to consummate the transaction. It should also authorize the proper officers to issue the stock consideration and deliver it against the delivery of the duly assigned property for which it pays. 7 341. Treasurer's Bond; Depositary In all cases where a bond is required of the treasurer, the details of this bond should be submitted to the board and be formally approved by it before the treasurer assumes the active duties of his office. When the treasurer is agreed upon before this first meeting of the board as is usually the case it will be possible and entirely proper for him to have the form of his bond and the name or names of his proposed sureties ready for submission at the first convenient interval in the board proceed- ings after his election. The form and sureties of the bond, if approved, should be formally accepted, and the instrument after execution be entrusted to either the president or secretary for safe-keeping. The treasurer will then at once enter on his duties. At times the approval of the treasurer's bond is left to the executive committee or even to the president. The by-laws should already have provided that the funds of the corporation be deposited in some bank or trust company, or one or more of these institutions as may be necessary and as 7 See Book IV, Forms 94. 97. 284 CORPORATE LAW [Bk. I- may be designated by the directors, and that such funds be drawn out only by check signed usually by specified officers of the corporation. It now devolves upon the board to designate the corporate depositary. This is done by means of a resolution, of which a copy is furnished the selected institution at the time of opening the account. This copy should be certified by the secretary, and the names of the officers authorized to sign checks and the form of signature should also be certified to the bank. 8 Often the banks have their own special forms for such resolutions of corporate depositors. In this case the resolution would con- form to the bank's requirements. 342. Other Business Many matters of lesser importance will be brought before the first meeting of directors, according to the particular conditions. Authority may be needed to rent and furnish suitable offices for the new corporation. In some states provision must be made for a state agent and office. Various statutory requirements must be fulfilled. Certain certificates and reports may need authorization. Details of the general business require considera- tion. The treasurer should also be authorized and instructed to pay out of the new corporation's funds the expenses of incorpora- tion, including counsel fees and organization taxes. If all the matters requiring attention cannot be properly con- sidered at this first session of the board, adjournment should be taken to the next day or to some other convenient date. Such adjourned meeting is considered as merely a part or a continua- tion of the original meeting, and reassembles at the appointed time without formality and completes its work. If, on the other hand, the board adjourned without date, it could only be reas- sembled prior to the next regular meeting by the methods prescribed in the by-laws for the calling of special meetings. Matters requiring the attention of the board are usually so numerous in the first days of the corporate existence that it is a 8 See Book IV, Forms 144-146, 224-226. Ch. 36] FIRST MEETING OF DIRECTORS 285 wise precaution even if not necessitated by business actually on hand to adjourn the first meeting over a few days. Then if necessary, the adjourned meeting may be held. If not neces- sary, the members need not attend and the meeting will lapse, the effect being then exactly the same as if the board had ad- journed without date at the first meeting. Part VIII Stock Records and Stock Transfer CHAPTER XXXVII THE STOCK RECORDS 343. Transfer of Stock on Books of Corporation As a rule, the issue of stock is evidenced by the issue of stock certificates, and transfers of stock are effected by assignment of these certificates. The due possession of a properly issued stock certificate, or of such a stock certificate duly assigned, is there- fore sufficient evidence of the ownership of stock for all ordinary business purposes. For all corporate purposes, however, stock certificates are merely secondary evidence of stock ownership, the stock books of the corporation affording the highest evidence of title. 1 In many states this is a matter of statutory regulation; elsewhere, of charter or by-law provision, such statutory or corporate regulations ordinarily prescribing that transfers of stock shall be made only upon the stock books of the corporation and that "stockholders of record," i.e., those whose names appear upon the stock books of the corporation, are alone entitled to exercise the usual rights of stockholders. Thus it will be seen that, while the duly assigned stock cer- tificate is good evidence of the ownership of stock, such ownei- ship is not effective for corporate purposes until the transfer has been recorded upon the stock books of the corporation. The 'Cleveland, etc., R. R. v. Robbins, 35 O. St. 483 (1880); Brisbane v. Del., etc., R. R.. 94 N. Y. 204 (1883). 287 288 CORPORATE LAW [Bk. I- holder of such a certificate may force the proper entries upon the corporate books but he cannot exercise the rights of a stock- holder until such record has been made; hence the importance of a carefully kept stock book. Upon the wrongful refusal of the corporation to transfer stock, the owner has three remedies. He may treat the refusal to transfer as a conversion of the shares in the corporation and sue for their value; he may assert his ownership and sue for the dividends; or he may commence an action 2 to compel the transfer upon the books of the company. The conditions must determine which is the best course. A practical application of this rule is found in the usual provision that the transfer books of the corporation shall be closed a specified number of days before elections or dividend days. This absolutely prevents any change of ownership for corporate purposes during the closed period and avoids the confusion that would otherwise exist when preparing for pay- ment of dividends, sending out notices of meetings, and deter- mining who is entitled to vote at elections. Stock may be sold without restriction during this closed period, transfers being evidenced by assigned certificates, but the record of these trans- fers on the corporate books cannot be effected until the stock books are again opened. 3 If no stock certificates were issued, the interests of the stock- holders of a corporation might still be assigned very simply, either by transfer on the books of the corporation by the parties in person in the presence of a corporate official, or by the execu- tion of formal instruments of assignment so attested as to satisfy the corporate transfer officer of their validity. 4 The books of the corporation used in connection with the issue and transfer of stock are the stock certificate book, the stock ledger, and the stock transfer book. 2 Travis v. Knox Terpezone Co., 215 N. Y. 259 (1915). See { 349- 4 May v. McQuillan, 129 Mich. 392 (1902); Lipscomb v. Condon, 56 W. Va. 416 (1904). Ch. 37] THE STOCK RECORDS 289 344. Stock Certificate Book The stock certificate book consists of blank stock certificates which, numbered and in serial order and each with its corre- sponding stub, are bound up in book form. The board of direc- tors has power to prescribe the form of stock certificates and to direct their issue. 5 The stock certificate book is usually prepared at the time the company is organized or sometimes even before, so that cer- tificates may be issued as soon as the corporate officials have been authorized thereto. In this case the form of stock certifi- cate is approved and the issue of certificates authorized at the first meeting of the board. On the other hand, the issue of permanent certificates is sometimes deferred for a considerable period on account of the time required for their preparation, or to temporarily save expense, or for some other reason. Under such circumstances, temporary receipts or certificates are issued which are exchangeable for the permanent certificates as soon as the latter are ready for delivery. When an issue of stock is directed, the secretary fills out and seals in numerical order the proper certificates. At the same time he enters on the stub of each certificate the name of the party to whom it is to be issued, the number of shares repre- sented by the certificate, the date of issue, and, if it is an original issue, that fact is noted on the stub; if a reissue, the number of the certificate surrendered is entered. The stub also usually includes a receipt to be signed by the party to whom the certifi- cate is issued, and a blank on which, when the certificate is surrendered for cancellation and reissue, the number of the cer- tificate issued in its stead is entered. The stub when filled out thus contains a complete record of its particular certificate. When stock is to be transferred, a new certificate should never be issued until the old certificate, properly indorsed, has been surrendered; except that where a certificate has been lost * See Book IV, Ch. VI, "Stock Certificates" (forms). See Book IV, Ch. V, "Subscription Receipts and Records" (forms)- ago CORPORATE LAW [Bk. I- or destroyed, it should be replaced upon the filing of a proper bond of indemnity and compliance with any other requirements of the by-laws. The surrendered certificate should, as soon as received, be canceled by cutting, punching, or crossing out the signatures and by writing or stamping across the certificate the word "Canceled." This is done to prevent the certificate from being reissued or from being used for fraudulent purposes in case it is stolen or otherwise comes into the hands of improper parties. After cancellation the certificate is gummed to the stub from which it was originally taken, the proper entries are made upon the stub, 7 and, so far as that particular certificate is concerned, the matter is closed. A surrendered certificate should never be reissued or again put in circulation under any circumstances. Every precaution should be taken to avoid mistakes in issuing certificates. The entries on the stub should be made before the certificate is separated from it. Certificates with space for the name left blank to be filled in later, should never be issued. Such a practice prevents absolutely the accurate recording of the stockholders of the corporation, which is legally essential. A corporation is responsible for any fraud or error committed by its agents in the issuance of stock. The secretary usually has charge of the stock certificate book and prepares the certificates for issue. Where the secre- tary receives no regular salary or in cases where there are numer- ous small transfers of stock, he is sometimes authorized by the by-laws or by resolution of the board of directors to charge a small fee for transfers. 9 In the smaller corporations the stock certificate book is fre- quently the only "stock book" maintained. This practice is informal and does not keep the record of stockholders in con- venient shape for reference, but in the absence of statutes * See Book IV, Forms 78-81. N. Y. & N. H. R. R. Co. v. Schuyler, 34 N. Y. 30 (1865). See I 259; also Giesen v. London, etc., Mortgage Co., 102 Fed. Rep. 584 (1906). Ch. 37] THE STOCK RECORDS 291 requiring other stock books to be kept is not legally objection- able. The stock certificate book then affords the sole record of those who are stockholders and entitled to vote and receive dividends. 10 345. Taxes on Stock Transfers In most of the states there are inheritance tax laws, taxing the transfer of property of decedents, including shares of stock. If the estate equals or exceeds $50,000 in value, the federal in- heritance law taxes it on a sliding scale, beginning at i%, and going up to 25% on an estate of $10,000,000 or more. In Massachusetts, New York, and Pennsylvania, a stamp tax is imposed upon the sale or transfer of all stock. The federal law imposes a stamp tax of 5 cents on the origi- nal issue of each $100 of par value or fraction thereof, and 2 cents on each transfer thereafter. The corporation is responsible for any transfers permitted on its books without payment of taxes. 11 346. Stock Ledger and Stock Book In almost every state some form of stock record is prescribed by statute, variously termed a "stock book," "stock ledger," "transfer book," or "stock and transfer book." In some states both "stock books" and "transfer books" are required. The intent in all these states is to preserve an accurate record of the stockholders and the stock held by them. The stock ledger and the stock book are practically, and should be, one and the same book, ordinarily kept under the title "stock ledger" or such other title as may be prescribed by the statutes. This stock ledger must show in alphabetical order the names and addresses of the stockholders of record, the amount of stock held and from whom and when this stock was acquired, and, if any of their stock has been disposed of, to 10 Chemical Nat. Bank v. Colwell, 132 N. Y. 250 (1892); In re U. S., etc., Co.. 74 N. J. L. 315 (1907). "See Ch. XLI. "Stock Transfer Taxes; Corporate Taxes." 2Q 2 CORPORATE LAW IBk. I- whom and when it was transferred. It must also show the bal- ance of stock at any time- to the credit of any stockholder. This balance gives the number of shares upon which such stockholder is entitled to vote and draw dividends. 12 In some states additional data must be entered. Thus in New York the amount received by the corporation on any stock acquired by a stockholder must be recorded; in Missouri the amount of capital stock subscribed, the corporate assets and liabilities, and addresses of corporate officers must be included; in North and South Dakota instalments paid and unpaid and any assessments levied and paid or unpaid must be recorded; and in Colorado all pledges must be shown by the stock book. .tij [j . '.:. . li . j>- .IJ> / . / .W1J , 347. Statutory Rules as to Stock Books The statutes in many states are very peremptory in regard to the keeping of stock books, providing severe penalties for failure. Thus in New York the statutes not only prescribe heavy penalties for failure to keep stock books, but provide that no transfer of stock shall be valid as against the corporation, its stockholders, and creditors save to render the transferee sub- ject to a liability as a stockholder until the record thereof has been duly entered in the stock book. 13 In most of the states the stock book must be kept open for inspection of stockholders or creditors of the corporation, and the provisions relating to the stock books apply both to domes- tic corporations and also to foreign corporations doing business in the particular state. Under a recent statute in New York 14 this right of inspection has been somewhat curtailed, and the right is limited to judgment creditors of the corporation, stock- holders who have been stockholders of record for at least six months immediately preceding the demand, and to persons holding or authorized by persons holding stock to an amount u See Book IV, Ch. VII. "Stock Books" (forms). u N. Y. Stock Corp. Law, 32; Penal Law, 665. "Laws of 1916, Ch. 127; and Laws of 1918, Ch. 137. Ch. 37] THE STOCK RECORDS 293 equal to 5% of all its outstanding shares. There had un- doubtedly been abuse of the right of inspection for improper purposes, or for purposes entirely foreign 'to the corporation, but the statute in question has received much criticism. The stock ledger is usually posted from the transfer book, though it may be posted from the stubs of the stock certificate book; and its balances may be checked from time to time by comparison with the number of shares outstanding as shown by the open stubs of the stock certificate 348. Transfer Book The transfer book contains not only a record of transfers of Stock of the particular corporation, but also the actual instru- ments of assignment by which these transfers were effected. It is the book referred to by the usual form of stock certificate in the clause reading "transferable only on the books of the com- pany, etc." 16 In some of the states a transfer book is a statutory requirement. The transfer book is found in two general forms. As usually kept by the smaller corporations, it consists of a series of blank transfers or assignments bound in book form. These are filled out and signed by the owner of stock or his duly authorized attorney when the actual transfer of stock disposed of by him is made upon the books of the company. They are primarily designed to be formal evidence of the transfer of stock. They are also the secretary's authority for the issuance of new certifi- cates of stock to the assignee in place of the old certificates surrendered. A different form of transfer book is used by the larger cor- porations where the number of transfers is too great to permit of the convenient use of the form already described. In this book but one line is required for each transfer of stock, the transferee or his duly authorized attorney signing in the right- hand column. See Book IV. Form 78. "See Book IV. Form 85. 294 CORPORATE LAW [Bk. I- By reference to the assignment on the back of the stock certificate, 17 it will be seen that the assignment of the transfer book is practically a duplication of that on the back of the stock certificate, save that the power of attorney to transfer the stock on' the books of the corporation is omitted from the transfer book. As the duly executed assignment on the back of a surrendered stock certificate is a full and sufficient transfer of the actual ownership of the stock and justifies the secretary in issuing another certificate in the name of the assignee, many of the smaller corporations never keep a stock transfer book, relying entirely upon the stock certificate book with its stubs and duly assigned and canceled certificates for the record and evidence of authorization of transfers. When the transfer book is used, its assignment forms are signed either by the party making the transfer or by his duly authorized agent. Should the transferrer come in person as he has the right to do and sign a transfer on the stock transfer book, there is no legal necessity for his signature to the assign- ment on the back of the stock certificate. It is, however, always customary for him to execute the assignment on the back of the surrendered stock certificate as well. It is but seldom that the transferrer makes the transfer on the books of the corporation in person. In perhaps ninety-nine cases out of a hundred he merely signs in blank the assignment on the back of the certificate and turns it over to the purchaser. The name of the attorney to make the transfer is then inserted at the time the certificate is presented for transfer, either by the .party by whom the certificate is surrendered or by the secretary, who usually inserts his own name and makes the transfer. 349. Closing the Books In all the larger corporations it is customary to close the stock books to transfers prior to both elections of directors and See Book IV. Form 81. Ch. 37] THE STOCK RECORDS 295 the payment of dividends, 18 for a period of from 2 to 40 days. This is done to enable the corporate officers to make an accurate list of those entitled to receive notice of meetings and to vote thereat or to receive dividends. In a number of states the statutes expressly authorize the stock books to be so closed to transfers. Where this is not the case, it may be provided for in the charter or by-laws. The precise number of days for which the transfer books are closed is usually fixed by the by-laws. The resolution declaring divi- dends usually fixes the number of days for which the books shall be closed before the dividend day, if this is not prescribed by the by-laws. In some cases the statutes or by-laws merely provide that stock shall be voted by the owner of record, as shown by the books of the company, 10, 20, 30, or 40 days before an election. This wording does not justify closing the stock books and refus- ing to make transfers. In such case transfers are made without interruption, but the secretary, in making up his lists of stock- holders for the election, ignores transfers made after the fixed date. No formality attends the closing of the stock books and usually no entry thereof is made upon the books, the secretary merely refusing to transfer certificates presented to him for that purpose during the prescribed period. The notice of the annual meeting or of dividends usually sets forth the days for the closing and reopening of the transfer books. w Jones v. Terre Haute, etc., R. R. Co., 57 N. Y. 196 (1874). CHAPTER XXXVIII TRANSFER OF STOCK 350. Procedure of Transfer When stock is to be transferred, one of the following courses is ordinarily pursued : 1. The certificate is assigned in blank and delivered to the transferee, in which case the assignment is absolute 1 and the certificate may then be passed from hand to hand and the owner- ship of the stock it represents be thereby transferred any desired number of times without change of or addition to the assignment. ' 2. The assignment on the back of the certificate is completed by the insertion of the name of the transferee and the delivery of the certificate to the transferee, in which case the certificate must be surrendered and a new certificate taken out by the trans- feree before it can be again transferred. 3. The assignor completes the assignment form on the back of the certificate, surrenders the certificate to the secretary of the company, and secures and makes delivery of a new certificate in the name of the transferee. 4. The certificate is delivered to the transferee without in- dorsement, but accompanied by an instrument of assignment or power of attorney having the same effect as the indorsement upon the back of the certificate. When transfer is made by delivery of the certificate with the name of the transferee inserted in the assignment, the transfer is not made on the books of the corporation until the assigned certificate is surrendered. In the meantime the original owner is still the owner of record and will therefore be held should any 1 People v. Utah, etc.,*Mines Co., 135 App. Div. (N. Y.) 418 (1909); Morris v. Hussong, etc., Co., 81 N. J. Eq. 256 (1013). 296 Ch. 38] TRANSFER OF STOCK 297 stockholders' liabilities arise, although as between the immediate parties the transfer is complete, and the transferrer could recover from the transferee any assessment or other moneys which he might be compelled to pay as a stockholder of record. This objection, when the stock transferred is full-paid, is not in most states material in the case of ordinary business corporations; but when stock of banks, trust companies, or other financial corporations is transferred, or when stock is not full-paid, it may be material and even vital. 351. Assignment in Blank When transfer is made by assignment in blank, and the blank has been filled so that it is a completed assignment, the transfer on the books of the corporation is not made until the transferee surrenders the assigned certificate. In practice the assignment in blank, on account of its con- venience, is employed in the great majority of stock transfers. When the holder of a certificate assigned in blank wishes to perfect his title and make himself a holder of record, he fills in his own name as assignee and surrenders the certificate to the secre- tary or transfer agent for transfer. He may also, if he sees fit, fill in the name of the party who is to make the transfer upon the books of the corporation, though this is usually left blank. If the signature to the assignment is genuine and there are no rea- sons for suspecting any irregularity, the transfer is made as a matter of course and a new certificate is issued in the name of the assignee. If the name of the attorney to make the transfer is left blank in the assignment of the surrendered certificate, the secretary of the corporation usually fills in his own name and then completes the transfer, thereby avoiding the delay that might result if some outside party were designated who must come in and sign the transfer book before the transfer could be duly recorded. When the assignment on the back of the certificate has been completed by the insertion of the assignee's name, the certificate 298 CORPORATE LAW [Bk. I- is not readily negotiable and is almost invariably turned in and a new certificate taken out. If, however, conditions make it necessary for the assignee to transfer the certificate originally assigned to him, he may effect the transfer by means of a second assignment in blank if desired written on the back of the certificate, or written on a separate sheet and attached to the certificate. 352. Rights of Stockholder of Record As already stated, stock assigned by indorsement of the certificate, whether in blank or complete, still stands on the books of the corporation in the original owner's name until the certificate is surrendered and the proper entries are made on the stock books of the corporation. Until this is done the original owner is still the stockholder of record and, while subject to any stockholders' liabilities accruing meanwhile, has, on the other hand, a legal right to vote and to receive payment of any divi- dends declared even though the actual sale of his stock was con- summated months before. 2 His right to vote is absolute, and after its exercise cannot hi any way be overturned or questioned. His right to dividends is qualified, as the dividends belong to the actual owner of the stock, i.e., the person possessing the duly assigned stock certificate, to whom the holder of record must account. His responsibility as to any stockholders' liability is, as to the corporation, absolute, but for any such payments he has recourse on his assignee. 353' Delivery of New Certificate Before delivering the new certificate, the secretary should, when possible, require the party who presented the old certificate for transfer who may or may not be the assignee to sign a receipt therefor on the stub. If the new certificate is delivered by mail, it may be registered, in which case the stub in the stock 2 Brisbane v. Delaware, etc., R. R. Co., 94 N. Y. 204 (1883); Cleveland, etc., R. R. Co. v. Robbins, Admr., 35 O. St. 483 (1880). Ch. 38! TRANSFER OF STOCK 299 certificate book, the office copy of the letter accompanying the certificate, and the returned registry receipt, which should be attached to the stub, make a sufficient record of the transaction. Blank receipts are sometimes sent with the certificates in such cases, to be signed by the recipient and returned, and these receipts when received by the secretary are pasted on the proper certificate stubs. 354. Sale of Part of Holding Frequently the owner of stock wishes to sell or transfer only a portion of the stock represented by a certificate, and in such case the assignment on the back of the certificate may be filled out according to the facts. For instance, if Howard Fielding owned 100 shares of stock, all included in a single certificate, and wished to sell 20 shares to James Wilton, he might fill out the assignment as follows: "unto James Wilton twenty shares and Howard Fielding eighty shares," or if the secretary will accept the somewhat informal assignment, it might be merely filled out "unto James Wilton twenty shares," it following as a matter of course that if only 20 shares are assigned, the balance of the stock remains with the assignor. The owner of the 100 shares then brings or sends in his certificate to the secretary and instructs him to make out two new certificates one for 20 shares in the name of the new owner, the other for 80 shares in his own name. The secretary makes the proper entries on the stock book, cancels the old certificates, issues the two new certificates in accordance with his instructions, and delivers both unless he has express instructions from the original owner to the contrary to this original owner, who then makes delivery of the 2o-share certificate at his convenience. The secretary must be governed entirely by the instructions of the assignor in delivering new certificates, no matter in whose name these certificates may be issued, as they are still in fact the property of the original owner. Another and usually preferable method when but a portion 300 CORPORATE LAW [Bk. I- of the stock represented by a certificate is to be transferred, is for the original owner to have the new certificates issued to him- self. When this is to be done, he fills in his own name as assignee, instructing the secretary to issue new certificates for the proper number of shares. In the case instanced he would have two certificates issued one for 20 shares and the other for 80 shares in his own name. He would then assign the 2oshare certificate in blank, or in the name of the new owner, and deliver it if the transaction is concluded. The new owner may then bring in and surrender this assigned certificate and take out a new certifi- cate in his own name at his convenience. When this plan is followed, even should the sale fail after new certificates were issued, the original owner still has the stock standing on the books of the corporation in his own name and both certificates made out to him; whereas if the first plan had been followed, one of the certificates being made out to the proposed purchaser, part of his stock would stand on the books in the transferee's name, and the real owner must either secure the assignment of this other party as a matter of courtesy, or otherwise be put to much trouble to get the certificate back into his own name. 355- Breaking Up a Certificate When a certificate is surrendered for reissue in one or more certificates in the original owner's name, the transfer may be entered on the transfer book as a matter of record, but as the owner's stock account is not affected one way or the other by the transaction, it should not be posted therefrom to the stock book. A memorandum of the facts should be made in the transfer book and on the stubs of the certificates involved in the reissue, and the certificate numbers in the stock book must be corrected. 356. Duty of Officers to Transfer Stock The secretary or officers of the corporation must refuse to transfer or reissue stock until the old certificate has been sur- Ch. 38] TRANSFER OF STOCK 301 rendered or until any other proper requirements have been com- plied with. When, however, all proper requirements have been met, they must make the desired transfer or reissue. 3 The authenticity of the signature to an assignment of a stock certifi- cate must be satisfactorily established when necessary. In the smaller corporations the secretary is usually familiar with the signatures of the stockholders. The larger corporations some- times require the signatures to be witnessed or guaranteed by some person known to the transfer agent, or otherwise that they shall be formally acknowledged before a notary public. If there is any doubt as to the authenticity or correctness of the assign- ment or as to the title of the party presenting the certificate, or as to any other material matter, the secretary has the right to delay the transfer for a reasonable time in order to communicate with the former holder or take such other steps as he may deem expedient. If after due investigation there still remains doubt as to the propriety of the transfer or the ownership of the certifi- cate, or if there be conflicting claims, the secretary may properly decline to act until instructed by the board of directors, and the board, if in doubt, may decline to take action in the matter until ordered thereto by some court of competent jurisdiction. * Jones v. Terre Haute, etc., R. R. Co., 57 N. Y. 196 (1874); Robinson v. National Bank of New Berne, 95 N. Y. 637 (1884). CHAPTER XXXIX TRANSFER OF STOCK (CONTINUED) 357- Transfer of Treasury Stock When treasury stock is donated to, or otherwise acquired by, a corporation, the assignment may run to the corporation direct, as "John Marshall Company"; to its treasurer, as "Treas- urer of John Marshall Company"; or to a trustee, as "John H. McGowan, Trustee for John Marshall Company." The certificates so assigned are canceled when received and the proper entries are made on the transfer book and stock ledger. When such stock is held in the name of the company or even by the treasurer of the company, no new certificates need be issued until the stock is sold, the fact that certificates are not issued being noted on the stock books. When a sale of such stock is made, the new certificates are made out direct to the purchaser. Certificates might properly be issued meanwhile in the name of the company or to the treasurer if desired, but such issue is unnecessary as the data of the transfer book, the entry on the stock ledger, and the canceled certificates are quite sufficient to evidence the transaction. It is obvious that the reasons that make the certificate desirable when stock is held by an individual, do not apply when a corporation holds its own stock. When treasury stock is sold, the secretary is authorized by due resolution of the board of directors to issue the proper certificates. Such transfers are entered on the stock books of the corporation as in case of any other transfer of stock. If certificates are not issued for the stock while held by the cor- poration, this fact should be noted on the stock books. It is not necessary to issue certificates until the stock is sold. 302 Ch. 39] TRANSFER OF STOCK 303 358. Transfer Agent and Registrar A transfer agent, in the modern acceptation of the term, is one who supervises and certifies transfers of corporate stock. The extent of his supervision depends upon custom or upon the particular agreement. A transfer agent usually keeps the stock certificate book in his custody. When a transfer is to be made, the certificate of stock duly assigned is surrendered to the transfer agent, who thereupon cancels the surrendered certificate, attaches it to its proper stub, and issues a new certificate in the name of the trans- feree. This certificate is then sent to the proper corporate officials who affix their signatures and the corporate seal unless the seal is also entrusted to the transfer agent make the proper records in the transfer and stock books, and return the signed, or signed and sealed, certificate to the transfer agent. The transfer agent thereupon seals the certificate if not already sealed, indorses it in evidence of its due issue, delivers it to the transferee, and the transaction is closed. Occasionally when a transfer agent is employed, the stock certificate book is retained in the custody of the corporation. In such case when a certificate is presented for transfer, it is canceled by the transfer agent and turned over to the corporation in exchange for a new certificate issued in the name of the trans- feree. This certificate is indorsed by the transfer agent and delivered to its owner. When the stock certificate book is kept by the corporation, the transfer agent keeps an independent record of stock certificates issued and surrendered, in order that the regularity of any particular transfer or issue may be readily and definitely ascertained. A registrar is a corporate appointee who also supervises the transfer of corporate stock but does not usually carry his super- vision to the same extent as does the transfer agent, his function being merely to register stock as issued. He maintains a record of all stock certificates issued and of the surrender and reissue of any new certificates with the names of the parties to the transfer. 304 CORPORATE LAW [Bk. I- If an issue or transfer is to be made, the registrar passes upon the certificates and countersigns them if they are correctly issued. His signature is evidence of due issuance. It will be seen that the duties of the transfer agent and regis- trar are distinct, and should not be performed by a single person or institution. The function of the transfer agent is to insure the proper issue of stock. The function of the registrar is to insure the regularity of issue and to prevent overissues. The functions of the two somewhat overlap, as the transfer agent would not permit an overissue of stock nor would the registrar sign stock improperly issued. It is obvious that the work of a transfer agent and registrar to be effective must be discharged by persons or institutions of the highest character and unquestioned standing. For this reason trust companies or banks are usually appointed. Speaking generally, the employment of transfer agents and registrars is advisable whenever transfers of stock are likely to be numerous. The procedure involved is simple in theory but in practice involves much detailed work. Also it is usually desirable that transfers be effected rapidly and accurately. The employment of the proper transfer agent and registrar, or transfer agent alone, relieves the corporate officials from the detailed work and responsibility involved, reduces the possibility of fraud or error in the issuance of stock to a minimum, and affords a general safety and convenience not otherwise secured. Stock exchanges require that the securities listed by them shall be issued through suitable transfer agents and registrars. 359> Lost and Stolen Certificates A stockholder, so shown by the books of his company, is entitled to every right and privilege of a stockholder without regard to the whereabouts of his certificate. 1 When certificates are lost, the owner usually desires to have new certificates issued, not in order to secure any corporate 1 National Bank v. Watsontown Bank, 105 U. S. 217. 222 (1881); Birmingham National Bank v. Roden, 97 Ala. 404 (1892); Wheeler v. Millar, 90 N. Y. 353 (1882). Ch 39] TRANSFER OF STOCK 305 rights, but merely to have his interest in such shape that he may readily sell, pledge, or otherwise use his stock. Stockholders have a general right to certificates 2 and, if their certificates are lost, to have them replaced; but before it reissues any such certificates, the corporation on its part has the right to require reasonable safeguards for its own protection. 3 The by-laws should outline the proper procedure, which must conform to any statutory requirements. 4 A bond of indemnity is usually and properly required before a lost certificate is replaced, as it is always possible that the missing certificate may turn up in the hands of an innocent purchaser for value, who might have cause for damages against the corporation if it refused to recognize his rights. It is but seldom wise to reissue lost certificates unless such bond is given. Only the absolute and irrecoverable loss of a certificate, as in case of its unquestioned destruction by fire, would justify an unprotected reissue. When the value of missing certificates is considerable and the circumstances are doubtful, it is sometimes best for the directors to refuse absolutely to replace the certificates until the owner secures an order from some court of competent jurisdiction. When this is done the directors are relieved from all responsibility in the matter. The officers of the company should never take the responsibility of reissuing a lost or stolen certificate of stock without express authorization from the board of directors. Should they do so and the missing certificate turn up in such a way that loss is involved, they would be responsible to the corporation. In case certificates are lost or stolen, the secretary of the company or its transfer agent should be immediately notified, and such other steps be taken as may be necessary to prevent the negotiation of the missing certificates. When lost certifi- ! Buffalo, etc., R. R. v. Dudley, 14 N. Y. 336, 347 (1856); Fletcher v. McGill, no rnd. 39S (1886). ' See Book IV, Form 249; also Guilford v. W. U. Tel. Co., 43 Minn. 434 (1890); Butler v. Glen Cove. Starch Mfg. Co., 18 Hun 47 (1879). See Book IV, Forms 65, 66. .306 CORPORATE LAW [Bk. I- cates are indorsed in blank and are presented to the transfer officers of the corporation before these officials have been notified of the loss, they may make the transfer, and the corporation will not be liable to the owner if the circumstances were such as to justify the belief that such transfer was regular and in good faith. If, however, the proper officials have been warned of the loss, or the circumstances were such as to put them on notice, they could not safely make such transfer. 360. Negotiability of Stock Certificates In states where the common law prevails, a stock certificate is not perfectly negotiable as are notes, drafts, and other forms of negotiable paper, but is quasi-negotiable, and usually an innocent purchaser for value of a properly indorsed certificate is protected. 5 "Excepting in cases of certificates transferred in blank and lost or stolen without negligence on the part of the owner, a bona fide purchaser is protected now in almost every instance where he would be protected if he were purchasing a promissory note or other negotiable instrument." 6 Thus a party finding or stealing certificates of stock, even though these certificates are indorsed in blank, takes no title, nor does anyone who buys the lost or stolen certificates from him, the title remaining in the original owner. ? If, however, a lost or stolen certificate is surrendered to the corporation and a new certificate received in its place as might readily be the case if the corporate officials were not promptly notified of the loss any purchaser in good faith of this new certificate takes a clear title. The original owner has then lost all rights in the matter save that of bringing suit against those through whose hands the certificate passed before its reissue by the corporation. In case of any doubt or any dispute as to ownership of a * Knox v. Eden Musee Co., 148 N. Y. 441 (1896); Trust & Sav. Co. v. Home Lumber Co., 118 Mo. 447 (1893). 2 Cook on Corp., { 416; Real Estate Trust Co. v. Bird, 90 Md. 229 (1899); Jarvis v. Manhattan Beach Co., 148 N. Y. 652 (1896). 7 O'Herron v. Gray, 168 Mass. 573 (1897); Hannahs v. Hammond Typewriter Co., 158 App. Div. (N. Y.) 620 (1913); Barstow v. City Trust Co., 216 Mass. 330 (1914)- Ch. 39] TRANSFER OF STOCK 307 certificate, no transfer should be made by the corporation until the true ownership has been definitely determined. > Oil) ,':. "!93Kf4qh?g(J 361. The "Uniform Transfer Act" 1 In order to secure the greatest possible security to purchasers of stock, and to facilitate the free transfer of shares, an act known as the "Uniform Transfer Act" has been, adopted with) only slight variations in form in New York, Pennsylvania, Massa- chusetts, New Jersey, and a number of other states. By this act certificates of stock are made negotiable instruments subject to the rules of the law governing commercial paper. The step is really not a radical one, for, as has been shown, the courts have gone far in cases under the common law to protect bona fide purchasers. The statutes, of course, are not extra-terri- torial in their scope, and by provisions in the acts themselves apply only to certificates issued after their passage. iKnrji-mnJ k rioue IwlJ ^ood rjiamnl-i) 362. Pledges of Stock The quasi-negotiability of stock, and in many states its full negotiability, renders its use as a pledge or collateral security a very simple matter, effected by the mere indorsement and de- livery of the certificate. 8 The usual procedure is for the pledger to give his note for the amount secured, the note reciting the pledge of stock and the terms under which it is held. These terms usually empower the pledgee to sell the collateral without notice to the pledger. The delivery of the stock as security is, however, the essential feature constituting the pledge without any written contract, 9 which is necessary only as a record and proof of the transaction. The pledgee may or may not, at his option, have the pledged stock transferred on the books of the corporation to his own Christian v. Atlantic & N. C. R. R., 133 U. S. 233 (1890); Seymour v. Hendee, 54 Fed. Rep. 563 (1893); Atkinson el al. v. Foster, 134 111. 472 (1890). Masury v. Arkansas National Bank, 93 Fed. Rep. 603, 607 (1899); Spreckels v. Nevada Bank, 113 Cal. 272 (1896); Brick v. Brick, 98 U. S. 514 (1878). 308 CORPORATE LAW [Bk. I- name. 10 If transferred, the word "pledgee" should follow the name of the owner on the new certificates of stock or otherwise the phrase "as collateral security" should appear on the certif- icates so as to characterize definitely the nature of the pledgee's holding. A memorandum of the facts should also appear in the stock ledger against the entry in both pledgee's and pledger's accounts. 11 Such entries, if showing clearly the nature of the transaction, relieve the pledgee of any corporate liabilities in- volved in the absolute ownership of the stock. 12 In some states the pledgee is expressly relieved from these liabilities by statute. 13 When stock is transferred on the books of the company to the pledgee, the voting right, as a general rule and in the absence of any agreement to the contrary, follows the stock. 14 In some states, however, as in New York, the owner of the stock may demand and receive a proxy from the pledgee upon paying any necessary expenses. In other states, as New Jersey, if it appears on the transfer books that such stock has been transferred only as a pledge, the owner retains the right to vote thereon. Statutes protecting the voting rights of pledgers are found in many states. When stock is pledged, the pledgee is entitled to receive any dividends declared meanwhile, and if the stock has been trans- ferred to the pledgee, or if the company has been properly notified that the stock is held in pledge, they must be paid to him. 15 In the absence of notice or transfer, as the pledger remains the owner of record of the pledged stock, dividends are properly paid to him, and the pledger and pledgee must then settle the owner- ship of the dividends between themselves. On the termination of the pledge, the pledgee must account for any dividends received by him. > Day v. Holmes, 103 Mass. 306 (1869); Fitchburg Savings Bank v. Torrey, 134 Mass. 239 (1883); Anderson v. Philadelphia Warehouse Co., in U. S. 479 (1884). " 2 Cook on Corp., 466. u Pauly v. State Loan & Trust Co., 165 U. S. 606 (1897); Tourtelot v. Stolteben, 101 Fed. Rep. 362 (1900). "Barre National Bank v. Hingham Manuf. Co., 127 Mass. 563 (1879); Burgess v. Selig- man, 107 U. S. 20 (1882). w Commonwealth v. Dalzell, 152 Pa. St. 217 (1893); Re Argus Printing Co., i N. Dakota 434 (1891); s. c., 12 L. R. A. 781, and note. Fairbanks v. Merchants National Bank, 132 111. 120 (1889); Guarantee Co. v. East Rome Co., 96 Ga. 511 (1895); Nat. Bank v. Equitable Trust Co., 227 Fed. 526 (1915). Ch. 39] TRANSFER OF STOCK 309 363. Rights of Pledgee on Default Upon default in payment of the amount it secures, the pledgee has the right to sell pledged stock. If the note or other memorandum of the pledge contains no agreement or provision for such sale, the pledgee must give the pledger due notice of his intention to sell the stock, and thereupon may sell the stock at public sale and apply the proceeds to the payment of his debt. Notice must be given the pledger a reasonable time before the sale and such notice must specify the time and place of sale, both of which must also be reasonable. Two days' notice has on occasion been held sufficient, 16 and four days' notice when the parties lived in different towns. 17 When notice of time and place is waived by express terms of the pledger's agreement, as is usually the case, the pledgee may sell at any time after default. The sale must be by public auction unless otherwise agreed, must be in good faith, and an endeavor must be made to obtain a fair price. . The pledgee himself may not bid the stock in, either directly or indirectly. If he does, the pledger may have the sale set aside. In many of the states the whole matter of the pledge of stock and its sale is regulated by statute. At any time before sale the pledger may pay the debt and all interest and any reasonable expense involved in the pre- liminaries of the sale and claim his stock. This stock need not be the particular shares pledged but merely an equal amount of the same stock. 364. Restrictions on Transfers Every stockholder whose stock is paid for in full is entitled to transfer his stock freely. Even where the stockholders have entered into a contract to restrain the alienation of stock or have enacted by-laws for the same purpose, the courts have usually set the restraining provisions aside as being contrary to public * Edwards on Bailments, I 285. 17 Guinzburg v. Downs Co., 165 Mass. 467 (1896). 310 CORPORATE LAW [Bk. I- policy. 18 Charter provisions restricting the transfer of stocks have, however, been held valid. 19 In some states the statutes prescribe specifically that stock subscribed but not fully paid for in accordance with the sub- scription agreement is not transferable save with the consent of the corporation. Elsewhere charter or by-law provisions may give the corporation the right to refuse to register transfers of unpaid stock. 20 In the absence of such provision, the right of transfer is absolute and may be enforced against the corporation. 21 At times the restriction of stock transfers becomes desirable and various plans have been attempted to effect this end. The courts, however, defend this right so strictly that its legal waiver is difficult. Perhaps the most successful method, when all the parties are in agreement, as to the advisability of such restraint is to form a voting trust for a certain number of years. All the stock or all the stock entering into the agreement is placed in the hands of voting trustees appointed under the terms of the voting trust agreement and is held by them, withdrawn from sale, for the period of the trust. Such arrangements are effectual and are upheld by the courts in most states if they do not extend for an unreasonable period. 22 In some states they are expressly permitted by the statutes under restrictions as to the term of their duration, 365. Lien of Corporation At common law a corporation has no lien upon its shares for debts due to it from its stockholders. The authority for any lien which the corporation may have must, therefore, be found in the statutes, its charter, or its by-laws. 23 Where the lien is 18 Johnson v. Laflin, 103 U. S. 800, 803 (1880); Quiner v. Marblehead, etc., Co., 10 Mass. 476 (1813); Morris v. Hussong Dyeing Machine Co., 81 N. J. Eq. 256 (1913); Steele v. Farmers', etc., Telephone Assn., 148 Pac. Kan. 661 (1915); Kretzer v. Cole Bros., etc., Co., 181 S. W. Mo. 1066 (1916). 11 Longyear v. Hardman, 219 Mass. 405 (1914). j o Barrett v. King, 181 Mass. 476 (1902). "Craig v. Hespeira L. & W. Co., 113 Cal. 7 (1806); Kinnan v. Sullivan County Club. 26 App. Div. (N. Y.) 213 (1898). 21 See Ch. LVI, "Voting Trusts"; also Brown v. Britton, 41 App. Div. (N. Y.) 57 (1899); Williams v. Montgomery, 148 N. Y. 519 (1896); Hey v. Dolphin, 92 Hun (N. Y.) 230 (1895). " Cook on Corp., { 522; Driscoll v. West B. & C. M. Co., 59 N Y. 06 (1874). Ch. 39] TRANSFER OF STOCK 311 given by statute or charter, the lien is enforcible against the stock into whosoever hands it may come irrespective of whether the assignee has any actual knowledge of the statute or charter provision. 2 * Where an attempt has been made to create a lien by provision in the by-laws, it has generally been held that the stock is not bound in the hands of an assignee who took without notice, 25 actual or constructive, of the lien provision. In New York, Massachusetts, Pennsylvania, New Jersey, and the other states which have adopted the law regulating the transfer of stock, known as the "Uniform Stock Transfer Act," there can be no lien or restriction upon the transfer of shares by virtue of a by-law or otherwise, unless the right of the corporation to such lien or restriction is stated on the certificate of stock. 24 Curtice v. Bank, no Fed. 830 (1901); United, etc., Co. v. Winston, etc., Co., 104 Fed. 947 (1912). Driscoll v. West B. & C. M. Co.. 59 N. Y. 96 (1874); Bankers' Trust Co. v. McCloy. ISO S. W. (Ark.) 205 (1913). Jislji-j^ffj'jti rf>;r! -d aJssoqioo. "jri* no auioj[ OKI! os i ~ . .'it itiJ bnjs aiiobiqaug ^on ; . 'dl yd bovi'jD5i a.: 320! 10 '"81) t,J .8 ."J iX> CHAPTER XL TRANSFERS OF STOCK RULES 366. Responsibility pf Corporation as to Transfers It is the duty of the corporation to record all lawful trans- fers; and if it refuses, the record may be compelled by recourse to the courts, 1 or the corporation may be held liable in damages. 2 If there is doubt as to the identity of the transferee or the authenticity of the transferrer's signature, the corporation may require proper proof thereof, and in cases where two parties claim the ownership of stock or where the corporation has been notified not to register a transfer, the corporation may, if there is any real uncertainty or reason therefor, decline to make any record on the corporate books until the matter has been settled by the courts. 3 The corporation is responsible if its officials record a forged transfer. 4 It is the duty of the corporate officials to know the stockholders' signatures, or otherwise to secure evidence of their authenticity before making a transfer. For this purpose they may require the personal attendance of the transferrer or clear proof that his signature is genuine. In case stock certificates indorsed in blank are lost or stolen, the corporation is not liable for receiving the certificates and transferring the stock represented thereby, if the circumstances are not suspicious and the transfer is made before notice of the theft or loss is received by the corporation. 5 1 Real Estate Trust Co. v. Bird, 90 Md. 229 (1899 ; Rice v. Rockefeller et al., 134 N. Y. 174 (1892). 1 Hine v. Commercial Bank of Bay City, 119 Mich. 448 (1899); Ralston v. Bank of Cali- fornia, 112 Cal. 208 (1896); Commercial Bank, etc. v. Kortright, 22 Wend (N. Y.) 348 (1839). 1 Tel. Co. v. Davenport, 97 U. S. 369 (1878); Athol Savings Bank v. Bennett, 203 Mass. 480 (1909); Amparo Mining Co. v. Fidelity Trust Co., 75 N. J. Eq. 555, 559 (1909). Cushman v. Thayer, etc., Co., 76 N. Y. 365 (1879); Chicago Edison Co. v. Fay, 164 111. 323 (1896). Mandelbaum v. North American Mining Co., 4 Mich. 464 (1857); Dewing v. Perdicaries, 06 U.S. 193 (1877). Ch. 40] TRANSFER OF STOCK RULES 313 367. Duties of Officers as to Transfers The officers of the company are the custodians of its stock- books, and it is their duty to see that all transfers of shares are properly made, either by the stockholders themselves or persons having authority from them. If, upon the presentation of a cer- tificate for transfer, they are at all doubtful of the identity of the party offering it with its owner, or if not satisfied of the genuineness of a power of attorney produced, they can require the identity of the party in the one case, and the genuineness of the documents in the other, to be satisfactorily established before allowing the transfer to be made. In either case they must act upon their own responsibility. 6 The record of any proper transfer, if refused, may be com- pelled by either transferrer or transferee. 368. Who May Transfer Stock Any person of full age who has not been adjudged incompe- tent, may transfer stock standing in his own name. All who are duly authorized to represent others, as attorneys, trustees, guardians, executors, and administrators, may transfer stock belonging to these others upon giving satisfactory evidence of their authority so to do. Stock belonging to minors and others incompetent to contract may be transferred only by their legally appointed and authorized representatives. The holder of unpaid stock, i.e., stock upon which the sub- scription or purchase price has not been fully paid, may as a rule transfer his stock without restriction, but in some states by statute provision such transfer is prohibited or may be made only by consent of the corporation. 369. To Whom Stock May Be Transferred There are but few restrictions as to the transferees of stock. A corporation may, if its officials see fit, refuse to transfer stock to anyone not competent to assume the obligations of a stock- holder, such as a minor or a person of unsound mind. Also a Tel. Co. v. Davenport, 97 U. S. 369 (1878). 314 CORPORATE LAW [Bk. I- corporation when in a failing condition may refuse to transfer stock to an irresponsible transferee. 7 Beyond these few excep- tions, stock may be transferred freely and in the absence of fraud the transfer is valid and must be recorded by the cor- poration. 370. Liability Involved in Transfers The liability of unpaid stock is enforced in every state. Full-paid stock, on the other hand, involves no liability to the corporation or its creditors whatsoever, save in the case of financial institutions on the stock of which a further liability is usually imposed and in those states in which by express statutory provision liabilities are imposed or assessments are permitted on stock even though full-paid. In those few states where liabilities do or may exist on full- paid stock, and transfers of such stock are made between parties competent to contract, any liabilities accruing before the trans- fer remain with the transferrer, but any liabilities accruing thereafter pass to the transferee. The liabilities of unpaid stock are affected by statute pro- visions in a number of states, but otherwise are subject to the general rules that the transferrer is liable for any calls or assess- ments already made and which are still unpaid, 8 but the trans- feree is liable for the amount that has not yet been called. An exception to this general rule obtains when a transfer has been made but has not been recorded on the books of the corporation. In such case the transferrer is still the owner of record and is therefore still liable for any amounts unpaid on his transferred stock and, if calls are made before the transfer is recorded, must pay them. He may collect these payments, if he can, from the transferee. Another exception to the general rule is found when the corporation has wrongfully issued stock certificates marked ' 2 Cook on Corp., JJ 395, 396. 8 May v. McQuillan, 129 Mich. 392 (1902); Sigua Iron Co. v. Brown, 171 N. Y. 488 (1902). Ch. 40] TRANSFER OF STOCK RULES 315 "Full-paid," in which case any bona fide purchaser of such cer- tificates without knowledge of the true character of the stock takes it free from liability to the corporation and to corporate creditors in case the corporation becomes insolvent. 9 This is also true when a purchaser in good faith takes over stock under such circumstances as to lead him to believe it is full-paid. In any such case, so far as the transferee is concerned, the stock is held to be full-paid and the corporation or its creditors cannot hold him liable. 371. Specific Transfer Liabilities In the following cases the rule as to the liabilities involved in transfers of stock is as set forth. A married woman may take stock in her own name, in practically every state of the Union, and take therewith every right and responsibility of ownership. 10 A minor may receive a transfer of stock and the corporation may record it if the corporate officials see fit, but as the minor may at will repudiate the whole transaction, the transferrer remains liable. 11 The same rule holds as to a transfer to a per- son known to be insolvent, the transferrer not being relieved from liability. 12 A transfer to an agent, attorney, trustee, guardian, adminis- trator, or executor in his own name, followed by a statement of the capacity in which he acts, as "James H. McLane, Agent," renders him personally liable on the stock so held, 13 except where expressly exempted by statute. 14 The same is true where a transfer is made to the treasurer of a corporation in his own name, as "Henry James, Treasurer." 15 yn -I' Rochester, etc., Co. v. Roe, 7 App. Div. (N. Y.) 366 (1896); Spraguc v. National Bank, 172 111. 140 (1898); 42 L. R. A. 606. 10 i Cook on Corp., {5 250, 396. 11 Foster v. Chas, 75 Fed. Rep. 797 (1896); Foster v. Wilson, 75 Fed. Rep. 797 (1896). 12 Bowden v. Johnson, 107 U. S. 251 (1882); Rochester, etc., Co. v. Raymond, 158 N. Y. 576 (1899). u Wads worth v. Laurie, 164 111. 42 (1896); Winston v. Dorset Pipe, etc., Co., 129 111. 64 (1889). 14 Davis v. Essex Baptist Society, 44 Conn. 582 (1877); Lucas v. Coe, 86 Fed. Rep. 972 (1898). '* 2 Cook on Corp., } 724, and notes. 3l6 CORPORATE LAW [Bk. I- A transfer to two persons, as "George Howard and John Mackel," makes them tenants in common and each may be held for one-half of any liability on such stock and both must join in a transfer. 16 A transfer to a firm, however, as "Howard & Mackel," does not have this effect but creates a partnership holding and a partnership liability. 17 A transfer to an existing corporation authorized to hold stock, as "The Strathmore Scale Company," renders the as- signee corporation liable as is an individual on the stock trans- ferred. A transfer to a membership corporation or unorganized association, as "Grace Methodist Church" or the "Brooklyn Decorators' Union," is of doubtful legality, and, if the matter of liability is of importance, should not be recorded by the corporation until the right of the body to hold stock has been proved. If not authorized to hold stock, it cannot assume the liabilities of a stockholder. A transfer to a dummy stockholder, as in case of transfer to any other agent, renders the dummy liable if he has property sufficient to make the liability effective. 18 The party for whom the dummy is acting is, however, likewise liable as an undisclosed principal. 19 A transfer to a pledgee in his own name without qualification renders him liable. It is otherwise, however, if the nature of the transfer is shown by its form, as "Howard Fielding, Pledgee." 20 372. Form of Transfer A general form of assignment for stock is always printed or engraved upon the back of each stock certificate. If there were any reason therefor, stock might with equal effect be transferred by means of a separate assignment written or printed and w Markell v. Ray, 75 Minn. 138 (1898). 11 Barton National Bank et al. v. Atkins et al., 72 Vt. 33 (1899) . 18 Dunn v. Howe, 107 Fed. Rep. 849 (1901). w Pauly v. State, etc., Co., 16$ U. S. 606 (1897); Davis v. Stevens, 7 Fed. Cas. 177 (1879). 20 Robinson v. Southern National Bank, 180 U. S. 295 (1901); Pauly v. State Loan & Trust Co., 165 U. S. 606 (1897). Ch. 40] TRANSFER OF STOCK RULES 317 j-At vcf bns oi ' i^isjiBiT attached to its certificate. In such case the certificate should be more fully described and identified than is the case in the usual form of assignment. The signature to the assignment of a stock certificate must correspond exactly with the name on the face of the certificate, and should be witnessed. If the signature of the transferrer is entirely unknown to the transfer officer or agent, it should be guaranteed by some responsible party or be acknowledged before a notary public. If the party signing a transfer of stock acts in a representa- tive capacity, a description of the capacity in which he signs should be added to the signature, as "Howard Fielding, Trustee for Jane Hathaway." If a certificate, issued in her maiden name, is to be transferred by a married woman, the signature should be in the following form: "(Mrs.) Alice H. Walker, formerly Alice H. Ainsley." Occasionally a married woman holding stock in her maiden name wishes it transferred to the name acquired by marriage. In such case the signature to the assignment is similar to that just given and the blank for the name of the transferee is filled in as follows: "(Mrs.) Alice H. ,, H Walker. The name of the transferee should be written in the proper blank of the assignment form without abbreviation, complimen- tary title, or suffix, though where the transferee is a woman, the designation "(Miss)" or "(Mrs.)," as the case may be, is frequently and properly placed before the name. When a transfer of stock is to be received by an agent, it should be made out in the name of his principal, unless the agent is willing to assume any statutory liability on the stock transferred. When stock is transferred by an agent or one act- ing for another, the name of the principal should be appended to the assignment followed by the agent's name and a statement of the capacity in which he signs; thus, "Frank H. McClelland by Howard James, Attorney." 3 l8 CORPORATE LAW [Bk. I- 373. Transfers to and by Agents Any person competent to contract and wishing to transfer stock, may transfer stock or receive the transfer of stock through an agent. In case of transfer, the agent or attorney in fact should present the certificate to be transferred, accompanied by his power of attorney or a duly acknowledged copy thereof, which should be left on file with the transfer agent or officer of the corporation. Express authority to transfer stock should be given by the power of attorney and, if necessary, evidence should be furnished that the signature to the power is genuine, that the instrument is still in force, and that the party present- ing it is the party named therein. 21 In case of transfer by an agent, it is the duty of the corpora- tion to require satisfactory evidence of the agent's authority. Otherwise in case of a fraudulent transfer the corporation is liable. 22 The corporation is also liable if, with knowledge of the facts, it recognizes a power of attorney executed by a minor, an insane person, or anyone else unable to contract. 23 In case of transfers of stock to an agent, the certificates, as stated, should be issued in the principal's name, the agent merely receiving the certificates and receipting therefor for account of his principal. If a certificate is indorsed in blank and entrusted to an agent, and the agent assigns the stock fraudulently, the stock- holder has no recourse save against the agent, as his own act made it possible for his agent to perpetrate the fraud. 24 The rule is different, however, if the agent transfers the stock directly into his own name. In such case, if the corporation knew of the agency, it is liable, 25 and the original owner will not be estopped from reclaiming the stock. 21 Tel. Co. v. Davenport, 97 U. S. 369 (1878); Bayard v. Farmers', etc.. Bank, 52 Pa. St. 232 (1866). 21 TaSt v. Presidio, etc., R. R. Co., 84 Cal. 131 (1890); Tel. Co. v. Davenport, 97 U. S. 369 (1878). a Chew & Goldsborough v. Bank o Baltimore, 14 Md. 299 (1859). M P. R. R. Co.'s Appeal. 86 Pa. St. 80 (1878); Elliott v. Miller & Co., 158 Fed. 68 (1908). " Tafft v. Presidio, etc., R. R. Co., 84 Cal. 131 (1890). Ch. 40] TRANSFER OF STOCK RULES 319 374. Transfers to and by Executors and Administrators Before a transfer of stock by an executor or administrator is allowed, a certified copy of the appointment of the party act- ing should be filed with the corporation or transfer agent. Or in case there is a will, a certified copy of this instrument should be presented for inspection or filed with the secretary 26 for the reason that it has been repeatedly held that corporations are chargeable with notice of the contents of the will. 27 Such executor or administrator may transfer the stock directly from the deceased party to a purchaser, or may transfer the stock to his own name as administrator or executor, 28 or may pledge the stock if this be necessary. The corporation should not, however, permit him to transfer the stock to his individual name. 29 When there are two or more executors of an estate, one alone may not transfer stock; all must join. 30 Corporate officials recording transfers of executors or ad- ministrators with knowledge that a fraud or breach of official duty is involved therein, are liable to the estate. An adminis- trator or executor cannot compel the transfer of stock belong- ing to the estate when the corporation is domiciled in another state. A purchaser of stock from such an administrator or executor can, however, compel the corporation to recognize his right of property in the purchased stock and to issue to him new certificates. When a trust discharged by an executor continues for a long period, the executor becomes in fact a trustee and his transfers then become subject to the rules governing trustees. 31 The corporation must then refuse the transfer of stock unless the executor brings satisfactory evidence of his right to make such transfer. 26 See 2 Wills, Estates and Trusts by T. Conyngton el al., pp. 539, 540. " Wooten v. Railroad, 128 N. C. 119 (1901); Marbury, Trustee v. Ehlen, 72 Md. 206 (1890). 28 London, Paris & Am. Bank v. Aronstein, 117 Fed. Rep. 601 (1902). M i Cook on Corp., { 329; London, Paris & Am. Bank v. Aronstein, 117 Fed. Rep. 601 (1902); Chester Co.. etc., Co. v. Securities Co., 165 App. Div. (N. YJ 329 (1914). *> Bohlen's Estate. 75 Pa. St. 304 (1874); Tunis v. Pass. R. R. Co., 149 Pa. St. 70 (1892); IO Cyc., p. 594. Peck v. Bank, 16 R. I. 710 (1890); 2 Cook on Corp.. { 308. 320 CORPORATE LAW [Bk. I- 375. Transfers to and by Trustees The corporate officials must refuse the transfers of a trustee unless his authority is clearly established. His appointment must be in writing and expressly authorize the sale or transfer of stock. If such instrument exists in due form, duly certified, the trustee may compel transfers by the corporation when the certificates of stock are duly assigned by him in his representative capacity. 32 The corporation is responsible if it permits any transfer by a trustee not authorized by the trust instrument. 83 If there is more than one trustee, all must sign the transfer. 34 Trustees appointed by court should show a copy of the court appointment. Before stock is purchased from a trustee provided the cer- tificates of stock indicate that he is a trustee the purchaser should ascertain whether the trustee is authorized to make the sale. 35 "A certificate for shares of stock running to 'A. B., Trustee,' or to 'A. B. in trust,' without disclosing the names of the beneficiaries or the particulars of the trust, is notice to a purchaser of shares that 'A. B.' does not hold them in his own right, but as a trustee." 36 When transfers are made to a trustee, his representative capacity should be clearly indicated by reference in the certifi- cate to the will or other instrument under which the trusteeship was created, 87 and the name of the beneficiary should be men- tioned when possible; thus, "John Hayden, Trustee for Howard Waller under the will of Horace Waller." 376. Transfers to and by Minors A corporation may refuse to transfer stock to a minor as he is incapable of assuming the obligations of a stockholder. 38 Bird v. Chicago, etc., R. R., 137 Mass. 428 (1884). 33 Marbury, Trustee, v. Ehlen el al., 72 Md. 206 ("1890); Geyser-Marion Gold-Min. Co. v. Stark. 106 Fed. Rep. 558 (1901). 34 Bohlen's Estate, 75 Pa. St. 304, 312 (1874); Oliver v. Governor & Co., 86 L. T. Rep. 248 (1902). 36 First National Bank v. National Broadway Bank, 156 N. Y. 459 (1898); Shaw v. Spencer et al., 100 Mass. 382 (1868). 36 Gerard v. McCormick, 130 N. Y. 261 (1891). 7 Geyser-Marion Gold-Min. Co. v. Stark, 106 Fed. Rep. 558 (1901). 38 2 Cook on Corp., J 396. Ch. 40] TRANSFER OF STOCK RULES 321 In case such a transfer is made, the liability of the transferrer as a stockholder of the corporation continues until the minor becomes of age and ratifies the transfer. 39 Minors may receive and hold stock in their own names but cannot transfer stock so held. Assignments should therefore be made to their guar- dians in the following form: "Alfred Carr (minor) under guar- dianship of Henry B. Boerum." A minor is himself unable to make a legal transfer of stock even though the stock is held in his name, and the corporation renders itself liable for any resulting damages if it records such transfer. The only legal method of transferring a minor's stock is therefore by assignment executed by a duly appointed guar- dian." 377- Transfers to and by Guardians Certificates for stock owned by minors or other persons not competent to contract should properly be issued in the name of the trustee or guardian of such person. In most states parties not competent to contract cannot transfer stock, and therefore all transfers of stock belonging to such persons must be made by their legally appointed trustees or guardians. Usually the statutes require the guardian of a minor to be specially authorized by order of a proper court before he may sell stock belonging to his ward, and the corporation cannot safely record a transfer of a minor's stock though made by his guardian until it ascertains the existence of such authority." The guardian should therefore secure proper authority and file a certified copy thereof with the secretary of the corporation before or at the time the transfer is made. When no statutes regulate the sale of stock by guardians, a guardian may freely transfer stock without any special court authorization," though in this case it is safer for him to obtain " Foster v. Wilson et al.. 75 Fed. Rep. 797 (1896). Smith v. Baker, 42 Hun (N. Y.) 504 (1886); White v. New Bedford, etc., Corp., 178 Mass. 20 (1001). 41 Atkinson v. Atkinson,' 90 Mass. 15 (1864); O'Herron v. Gray. 168 Mass. 573 (1897). Lamar v. Micou, 112 U. S. 452 (1884). 322 CORPORATE LAW / KT (Bk. I- authority from the court as a measure of self-protection. A guardian has no authority to pledge stock. v,'i:)J'J'I - f/; >- .-] 378. Transfers to and by Corporations Under the common law, one corporation cannot hold stock in another." In a number of states, however, corporations are by statute expressly authorized to hold stock of other corpora- tions, or may be so authorized by inclusion of the power in their charters. Even where this is not the case, the general rule has been relaxed, and it may now be said in general that a corpora- tion may become a stockholder in another corporation wherever the stock is acquired in pursuance of a legitimate purpose of its creation.^ Hence an investment company, an insurance company, a trust company, and others of similar character, may properly invest in and hold the stock of other corporations. Also corporations may acquire stock by foreclosure proceedings or may take it in order to escape loss, as for instance, in settle- ment of a debt. 46 Also corporations are not uncommon in the present day, which are expressly authorized to hold stock in other corporations and have been organized for this purpose. 47 In all cases where the corporation properly holds stock, it has all the rights of a stockholder as to such stock, including the right to receive dividends and to have its representatives vote and, when duly elected, act as directors or officers of the cor- poration by which the stock was issued." As a rule a corporation may buy its own stock with its sur- plus profits, if not prohibited by statute and if all its stock- holders acquiesce. 4 ^ It may not, however,, do so except from surplus profits unless expressly authorized thereto by statute * O'Herron v. Gray, 168 Mass. 573 (1897). 4 People v. Chicago Gas Trust Co.. 130 111. Savingsjnst., 175 U. S. 40 (1899). v. Ro' ' 268 (1889); De La Vergne Co. v. German "Booth v. Robinson, 55 Md. 419 (1880); Layng v. A. French Spring Co., 149 Pa. St. 308 (1892). Robotham v/ Prudential Ins. Co., S3 Atl. Rep. (N. J.) 842 (1903). See Ch. LVII, "Holding Companies." Camden. etc., R. R. Co. v. Elkins, 37 N. J. Eq. 273 (1883); Rogers v. Nashville, etc., Ry. Co.. 91 Fed. Rep. 299 (1898); Windmuller v. Standard Distilling, etc., Co., 114 Fed. Rep. 491 (1902); Oelbermann v. New York, etc., R. Co., 77 Hun 332 (1894). See I Cook on Corp., 311; Lowe v. Pioneer Threshing Co., 70 Fed. Rep. 646 (1895). Ch. 4 o] TRANSFER OF STOCK RULES 323 since such procedure impairs and practically amounts to an illegal reduction of its capital stock. 5( > Transfers of stock held by associations, societies, or cor- porations must be made under the corporate seal by the duly authorized officers, and must be accompanied by a properly certified copy of the resolution or by-law authorizing the trans- fer. The certificate of authority should include a designation and statement of the due election of the, officers who are to act. Occasionally transfer agents or officers require an exemplified copy of the minutes or by-laws of the organization before they will register such a transfer. When stock is acquired by an association or society not incorporated, it is usually placed in the hands of trustees. 379' When Stock of Another Corporation Is Acquired When stock of another corporation is acquired by a cor- poration authorized to hold such stock, the assignment may run direct to the corporation or to its treasurer or to a trustee for the corporation, though if the stock actually and unreservedly belongs to the corporation, there is no reason why it should not be held in the corporate name. The certificates for such stock, assigned in blank or assigned direct to the corporation or the treasurer or a trustee if desired are turned over to the treas- urer or other designated officer of the transferee corporation, who presents the certificates for reissue, the new certificates being taken in the name of the transferee as indicated by the completed assignments on the back of the certificates. 380. When Stock of Another Corporation Is Sold W T hen stock of another corporation is held in the corporate name and is to be transferred, the corporate signature is affixed to the assignment by the duly authorized officer or officers of the assigning corporation. The corporation which issued the stock, before registering the transfer on its books, may and 10 McGill v. Underwood, 161 App. Div. (N. Y.) 30, 32 (1914). 324 CORPORATE LAW [Bk. I- should require proper evidence that these officers were properly empowered to affix the corporate signature. This proof is best supplied in the form of a certified copy of the resolution whereby the transfer of the stock was authorized. The procedure is much the same where stock is held in the name of the treasurer or a trustee for the corporation, save as to the signature to the assignment. 381. Transfers to and by Partnerships A partnership may deal in stock as freely as may individuals, and if it is a trading partnership, i.e., a partnership formed for the purpose of buying, selling, or manufacturing, si any member of the firm may sign the partnership name to a transfer of stock if this stock is held in the firm name. 52 The signatures of the individual partners to the assignment are not necessary, the firm name affixed by one of the partners being legally sufficient. The corporation may require evidence, when necessary, of the assigning partner's membership in the firm. If stock is issued to the partners as individuals, as "To John Gray and Henry H. Harriman," they are tenants in common and both the individuals named must join in any transfer. The same is true when the stock is held in the firm name if the partnership is not a trading partnership. Thus, if stock is held by a professional firm, even though in the firm name, the part- ners must sign their individual names to the transfer. In the absence of objection, any partner may vote on stock held in the firm name, but in case of disagreement the stock cannot be voted. 53 One joint owner cannot sell or vote stock standing in the names of two or more if the other objects, but each name must be signed to its assignment or to a proxy. 54 " Lee v. Bank, 45 Kan. 8 (1890); n L. R. A. 238. 62 Comstock v. Buchanan, 57 Barb. 127 (1864). 63 Matter of Pioneer Paper Co., 36 How. Pr. in (1865). M Tunis v. R. R. Co., 149 Pa. St. 70 (1892) ; s. c., 15 L. R. A. 665. Ch. 40] TRANSFER OF STOCK RULES 325 382. Summary of Rules Regulating Transfers The following rules regulating transfers of stock are those recognized by the trust companies of New York City and are given here as a very clear, concise summary of the general laws governing the subject. 1. The assignment of a certificate should be executed by the stockholder personally or by duly authorized attorney. In the latter case the assigned certificate should be presented to the transfer officials accompanied by the power of attorney under which the party acts, and the original or a notarial copy of this power should be left on file. Authority to transfer stock should appear in the power of attorney and, if necessary, the authenticity of the signature and the fact that the instrument is still in force must be proved. 2. The signature must be witnessed and must correspond with the name as written on the face of the certificate. Signa- tures unknown to the transfer agent should be guaranteed by some bank official or acknowledged before a notary public. 3. The name and full post-office address of the transferee should be given in full without abbreviation of any kind. The space for the name of the attorney should be left blank. (The address of the transferee is not entered in the assignment form but may be noted on the certificate or be furnished on a slip attached to the certificate.) 4. The full first name of the transferee should be given. If the transferee is a woman, the prefix "Mrs." or "Miss" should be used. No other prefixes and no suffixes should be used. 5. In transferring to a married woman, use her full Christian name not that of her husband. 6. In case a new certificate is required because of change of name by marriage, the old certificate should be signed "(Mrs.) Henrietta F. Bowen, formerly (Miss) Henrietta F. Francisco," while in the space for the name of transferee should be placed the name "(Mrs.) Henrietta F. Bowen." 7. Agents, attorneys, executors, administrators, guardians, 326 CORPORATE LAW [Bk. I- or trustees should not transfer stock to themselves directly, i.e., as individuals. 8. Transfers to a minor should give the guardian's name; thus, "Frederick McAllison (a minor) under guardianship of John J. McCall." Transfers to minors should be avoided if possible. Transfers from a minor can be made only by a guar- dian appointed by the proper court, who must exhibit a duly certified copy of appointment. q. A transfer by an administrator must be within his au- thority as evidenced by a copy of his appointment certified by the proper probate authorities. 10. A transfer by an executor must be accompanied by a copy of the will and appo'ntment, both certified by the probate authorities. The will is returned after inspection. 11. Transfers should not be made to a trustee, agent, or attorney who is not appointed by an instrument in writing. If properly appointed, the transfer must describe the trust by reference to the will or other instrument creating it. 12. In transfers by trustees when more than one all must sign and the transfer must be accompanied by a properly cer- tified copy of the instrument which authorizes the trustees to sell or transfer such stock. 13. In transferring to a society or institution, evidence should be required, if necessary, that it has power to hold and transfer stock. 14. Transfers by associations, societies, or corporations must be executed by duly authorized officers under seal of the organi- zation, and must be accompanied by a certified copy of the authorizing resolution or by-law. The regulations also prescribe generally that prompt notice of any change of address of a stockholder, stating the company in which the stock is held, should be sent to the transfer agent for record, and that lost certificates should be reported to the transfer agent as soon as the loss is discovered, with full descrip- tion of the missing certificate. CHAPTER XLI STOCK TRANSFER TAXES; CORPORATE TAXES STOCK TRANSFER TAXES 383. State Laws New York State was the first state to impose a stock transfer tax,i and has been followed by Pennsylvaniaz and Massachusetts^ In the three states the acts imposing the tax and the regulations for their enforcement are substantially uniform. Under each act transfers of stock of all domestic corporations and of all foreign corporations having transfer agencies within the state are taxable at the rate of two cents on each $100 of par value or fraction thereof. Many corporations of other states have transfer offices in New York, Boston, or Philadelphia. For this reason and for the further reason that other states may be ex- pected to adopt similar legislation, it seems not out of place to summarize the laws and regulations in connection with the gen- eral topic of stock transfer. 384. Duties and Penalties im; x.i r, oj ji feto^dua Ji ,ljjuj'j-jtlo It is the duty of the secretary or other officer of the corpora- tion in charge of the stock certificate book, to see in each in- stance, before issuing a new certificate, that all requirements of law have been complied with. In the case of the stamp transfer tax, this requires that he see that the proper stamps have been affixed and canceled and that a record of transfers be kept in such form as the law requires. In the case of the inheritance tax, the requirements differ under the statutes of the different states; the ' N. Y. L. 1905. Ch. 241. ' N. Y. L. I90S. Ch. 241. ! Pa., Act of June 4, 1915, P. L. 828. Mass., Gen. Acts, 1915, Ch. 238. 327 328 CORPORATE LAW [Bk. I- most usual provision forbidding the transfer until the inheritance tax has been paid or a waiver obtained from the state official charged with the collection of the tax. The corporation is in all cases made liable to a penalty if the requirements of the law are not complied with. 385. General Rulings as to the State Tax Practically identical sets of rulings governing the collection of the tax have been adopted in each state. These rulings are in substance as follows: 1. The statute does not apply to the original issue of stock. 2. The transfer to and from voting trustees is taxable, also the transfer of voting trust certificates. 3. The mere surrender of a certificate of stock for reissue in smaller denominations is not taxable; but if reissued in part to the original owner and in part to a third party, it is taxable to the extent of the transfer to the third party. 4. Likewise the mere surrender of a certificate of stock held by a deceased person for issuance in the name of his executor or administrator is not taxable; but all transfers made by the latter, whether to trustees, legatees, or other persons, are taxable. 5. While the law has no extra-territorial operation, neverthe- less where it appears that the transfer of the stock on the cor- porate books within the state is essential to render the transfer effectual, it subjects it to a tax although in all other respects made without the state. 6. It is the duty of the person making or effectuating the sale or transfer to pay the required tax by procuring, affixing, and canceling the stamps, except that where a sale or transfer is shown only by the books of the corporation, the person making the sale must secure, and the corporation affix, the stamps to its books and cancel them. 7. Where the sale or transfer is effected by the delivery or transfer of a certificate, the stamp must be placed upon the sur- rendered certificate. Ch. 41] STOCK TRANSFER TAXES 329 8. Under no circumstances may a stamp erroneously at- tached to a certificate or memorandum be removed. Other rulings dealing with the form of records to be kept and like matters var^ slightly in each state. 386. Federal Stamp Law 4 The federal law imposes on an original issue a stamp tax of 5 cents on each $100 of par value; and on all sales agreements to sell, or memoranda of sales, or deliveries of, or transfer of title to, shares or certificates of stock, a stamp tax of 2 cents on each $100 of par value or fraction thereof. This applies all over the United States. The law as to shares without par value reads as follows as to original issues: Provided, That where a certificate is issued without face value, the tax shall be 5 cents per share, unless the actual value is in excess of $100 per share, in which case the tax shall be 5 cents on each $100 of actual value or fraction thereof, or unless the actual value is less than $100 per share, in which case the tax shall be i cent on each $20 of actual value, or fraction thereof. And as to transfers: . . . where such shares are without par or face value, the tax shall be 2 cents on the transfer or sale or agreement to sell on each share. .. If a single $25 certificate of par- value stock were issued, the stamp tax on its original issue would be 5 cents, the transfer stamp on any later sale or transfer would be 2 cents. If the par value of the share were $175, it would require 10 cents on original issue and 4 cents on a transfer. If the certificate were for eight shares aggregating $200, the tax would be 10 cents on original issue and 4 cents on a transfer. In the case of no-par-value shares each certificate would 4 Revenue Act of 1921. Title XI, Sec. 1107, Schedule A, "Stamp Taxes." 330 CORPORATE LAW [Bk. I- require 5 cents in stamps for each original issue, unless the actual value of each share were over $100, in which case on original issue 5 cents would be required for each $100 or fraction thereof; or unless the actual value of each share were less than $100, in which case the tax would be i cent on each $20 of actual value or fraction thereof. That is, a certificate representing no-par-value shares of the actual value of $520 would require 30 cents in stamps, while one of the value of $25 would require 2 cents. For transfers of no-par-value shares a uniform rate of 2 cents on each share is imposed. The stamps representing the tax imposed shall be attached to the stock books and not to the certificates issued. 387. Penalties under Federal Stamp Law Anyone liable to pay the federal stamp tax on sales or trans- fers of capital stock, who makes any sale or delivery of stock without the proper stamps being affixed, is guilty of a misde- meanor punishable by a fine of not more than $1,000, or by imprisonment for not more than six months, or both, CORPORATE TAXES 5 388. Capital Stock (Excise) Tax It is provided in the Federal Revenue Act of 1921 that: 1. Every domestic corporation shall pay annually a special excise tax with respect to carrying on or doing business, equivalent to $i for each $1,000 of so much of the fair average value of its capital stock for the preceding year ending June 30 as is in excess of $5, ooo. In estimating the value of capital stock the surplus and undivided profits shall be included; . . . 2. Every foreign corporation shall pay annually a special excise tax with respect to carrying on or doing business in the United States, equivalent to $i for each $1,000 of the average amount of capital employed in the transaction of its business in the United States during the preceding year ending June thirtieth. 6 See Montgomery on Income Tax Proc. (1922) ; also Seligman's Essays on Taxation. Chs. VI, VII, VIII. Ch. 41] CORPORATE TAXES . 331 This tax applies to all corporations carrying on business for profit, and not to the enumerated corporations exempt from paying an income tax. It applies to all corporations and also to all associations for profit, and having a capital stock divided into shares It is to be noted that the tax is not on the par value, but on the "fair average value." To enable the Commissioner of Internal Revenue to estimate the fair average value, in cases of possible undervaluation, corporations are required to file three exhibits: A. Condensed balance sheet. B. Quotations or outside sales prices for past year. C. The annual income for a period of five preceding years. It is expected that the return should give as the fair average value the greatest value shown by any of the exhibits. This return must be filed during July of each year and is an excise tax to be paid in advance for the privilege of doing business for the year to come. The failure to make return in July to the Commissioner of Internal Revenue, unless good reason is shown, may add 25% to the amount of the tax. If a false or fraudulent return is made, the Commissioner shall add 50% to the amount. 389. Income Tax All business and manufacturing and public utility corpora- tions in business for profit are subject to the income tax levied by the general government. Under the law as amended in 1921, each corporation shall pay a tax of 10% of the net income subject to tax for 1921, and 12^/2% for 1922 and thereafter. In addition to this, each corporation up to January i, 1922, was subject to the excess profits tax which is considered in the next section. Every corporation shall make a return before March 15 of 332 . CORPORATE LAW [Bk. I- each year, itemizing its gross income and the allowable deduc- tions and credits. Corporations whose annual net income is below the $2,000 exemption are nevertheless required to make returns. The blanks for returns are furnished by the collector in each revenue district. To make out the return for a corporation of any size is a task requiring no small measure of legal and accounting skill. As a matter of fact the effect of the income and excess profits taxes has been to develop a new professional man, the tax expert. It has also developed many pretenders, who assume a skill in evading taxes that they do not possess. Tax returns should be honest returns, but every man is entitled to every exemption the law allows and also to shape his business so as to reduce his tax liability to the minimum. f 390. Excess Profits Tax Behind the excess profits tax was the idea that those corpora- tions that earned excessive profits should also pay taxes in larger measure. The excess profits tax is to be computed and deducted from corporate income before the normal tax is com- puted. Corporations having net incomes of less than $3,000 are exempt from payment of excess profits taxes. To find the income subject to the excess profits tax, the net income is taken before the credits allowed for the income tax are deducted, and from this is deducted: 1. $3,000, a specific deduction. 2. 8% of the invested capital. The rate of the excess profits tax is 20% of the amount of the net income in excess of the two deductions "and not in excess of 20 per centum of the invested capital, and 40 per centum of the amount of the net income in excess of 20 per centum of the invested capital." This tax ceases with the year 1921, i.e., is applicable to 1921 income but not to income arising in 1922. Ch. 41] CORPORATE TAXES 333 391. Local Property Taxes In every state the taxes on all property, both real and per- sonal, affect property in corporate possession, exactly as they affect the property of individuals or firms. A foreign corpora- tion doing business in a state must pay taxes on any property held for its purposes. Each state has its own system of reporting property for tax- ation and assessing taxes, and corporations have only to ascer- tain what is the local system and comply with the requirements. It may be necessary also to pay both city and county taxes. In those states where a license is required for some or all businesses before commencing operations, a corporation must comply with the law. In New York business corporations paying a state income tax are exempt from the local tax on personal property. 392. State Franchise Taxes Franchise or license taxes are annual payments required to be made by corporations, for the privilege of doing business under the corporate form in the particular state. In Michigan and a few other states there are no franchise taxes. This kind of taxation varies greatly in amount. In Penn- sylvania it is ]/2 of i% on actual values. In New York it took the form of a stock tax imposed in a complex plan on dividends or on the appraised value of the stock issued and outstanding, but this is for most corporations merged into the state income tax. In California it is 1.2% .on actual values. In Missouri it is .1%. In Iowa it is $i. In taxing no-par-value stock or in levying a franchise tax on a corporation with no-par-value stock, the usual rule is to consider each share as worth $100. In Colorado, for the organization and license tax, no-par shares are deemed to be of the par value of $i. The rule in Michigan is that the value is to be at least $i, or the sale value fixed by the corporation, or the book value. 334 CORPORATE LAW [Bk. I- In many of the states corporations engaged in mining or manufacturing in the state are exempt from the payment of any license fee or franchise tax. Sometimes it is specified that more than 50% of the capital must be so used to secure exemption from franchise tax. 393. State Income Taxes Only a few states have imposed an income tax on corporations as yet. It yields a large revenue, and is likely to become general. In New York the income tax is 4K% on the net corporate income. After January i, 1922, the federal tax on corporate incomes will be 12^2%, so that corporations doing business in New York will pay 17% income tax. In New York the net income on which the income tax is calculated "is presumably the same as the entire net income upon which such corporation is required to pay a tax to the United States." In Massachusetts the excise taxes are moderate, but in addition there is a tax of 2^% of that part of its net in- come derived from business carried on within the commonwealth. As in New York, the income report made to the federal govern- ment is taken as the basis of taxation. The Massachusetts law is comprehensive and provides for many details of procedure. The tax paid is divided, the state government retaining one-sixth, and the remaining five-sixth being distributed among the cities and towns in which the cor- poration maintains offices, stores, or factories. A foreign corporation doing business in Massachusetts pays the same rate of excise and income taxes on that portion of its capital employed in the state as is levied on domestic corporations. In North Carolina an income tax is laid of 3% on the total net income of domestic corporations. Foreign corporations are taxed proportionately at the same rate on the business done or property held in the state. In some other states corpora- tions are compelled to pay income taxes. Part IX Meetings and Records CHAPTER XLII ANNUAL MEETING OF STOCKHOLDERS 394. The Annual Meeting The annual meeting of stockholders is prescribed by statute in most states, and elsewhere is required by the charter or by- laws of the corporation. It is the only usual regular meeting of stockholders. If other meetings are necessary, they are "special meetings" and called as required. Stockholders' meetings must be held within the state of in- corporation. In many states the statutes so provide. Else- where it is a matter of common law,i save in some few instances, as in Delaware, West Virginia, and South Dakota, where the statutes expressly provide that stockholders' meetings may be held out of the state. The principal office of the company within the state is the customary and most appropriate place for stockholders' meetings and in many states is the place designated by statute. The by-laws usually prescribe the details of the annual meeting, such as the time and place, the notice required, the number necessary to constitute a quorum, the time of closing books, the officers of the meeting, and the order of business. By-law provisions also usually regulate the use of proxies, method of casting votes, and the employment of inspectors or tellers at elections of directors. Whenever there is any probability of the proceedings of the i Ormsby v. Vermont Mining Co., 56 N. Y. 623 (1874). 335 336 CORPORATE LAW [Bk. I- annual meeting being attacked, or when there are any dispute, or differences of opinion among the stockholders of a corporations every formality in connection with the annual meeting should be carefully observed. Under other circumstances such close observance, though always advisable, is not so essential. If the proceedings are characterized by good faith and are a fair expression of the sense of those present, "mere irregularities in the manner of conducting the business are immaterial."* 395 Closing Transfer Books The corporate calendar* should show the exact date prior to the annual meeting on which the transfer books are to be closed to transfers. The object of thus closing the books is to obviate any uncertainty as to who is entitled to receive notice of and to vote at the annual meeting. 396. Notice of Annual Meeting Notice of the annual meeting is usually prescribed by the by-laws and in some few states is required by statute. Such notice is not, however, of the same vital importance as in the case of special meetings, since the time and place of the annual meeting are specified in the by-laws and are supposed to be familiar to the stockholders. For this reason failure to send out notice of its time and place as required by the by-laws, while a very serious breach of duty on the part of the secretary is not ordinarily held to invalidate the proceedings of the meet- ing, save as to any unusual or specially important business considered thereat. 4 Where notice is prescribed by statute, however, the provision of the statute must be complied with unless waived by all the stockholders. The notice of the annual meeting should specify not only its time and place, but also its objects. This is not always legally J 2 Cook on Corp., $ 606. 1 See Book IV Form 267. Morawetz, 482; Warner v. Mower, n Vt. 385 (1839); Sampson v. Steam Mill, 36 Me. "8 (1853) ; Morrill v. Little Falls Mfg. Co., S3 Minn. 371 (1893)- For forms of notice, see Book IV Ch. XII "Notices of Meetings." Ch. 42 j ANNUAL MEETING OF STOCKHOLDERS 337 necessary but is an advisable precaution, particularly when busi- ness of special importance is to be considered thereat. "Where unusual business is to be transacted, even at a regular meeting, the notice of that meeting should state the unusual business." 5 In Pennsylvania it has even been held that important amend- ments of the by-laws cannot be legally effected at the annual meeting unless previously notified to the stockholders. 6 In the larger corporations the by-laws frequently provide specifically that any failure or irregularity in the notice of the annual meet- ing shall not affect its validity or the validity of any of its pro- ceedings. Written notice of the annual meeting mailed to the stock- holders of record is usually prescribed. This notice should be signed with the official signature of the secretary or other cor- porate officer authorized thereto, 7 and should be mailed, postage paid, on the date specified in the by-laws which ranges widely from 5 to 60 days or more before the date of the meeting to the address of each stockholder as shown by the books of the com- pany. A copy of the notice with date of sending indorsed thereon, should be preserved by the secretary as evidence that proper notice of the meeting has been given. Publication of the notice of an annual meeting is in some states required by statute, and in all states is customary among the larger corporations. It is, however, a most uncertain and inadequate method of notification and should be used only in connection with notice by mail. Copies of the papers in which the publication notice appears should be preserved by the secretary as proof of due publication; or if preferred, a copy of the notice may be made and an affidavit of the publisher or of the secretary certifying to its due publication be attached. 8 The notice of the annual meeting usually states the dates for the closing and reopening of the transfer books. * 2 Cook on Corp., f S9S- Bagley v. Reno, 201 Pa. St. 78 (1002). 7 Johnson v. Jones 23 N. J. Eq. 216 (1872). See Book IV, Forms 121-124. 338 CORPORATE LAW [Bk. I- 397. Preparations for Annual Meeting It is the secretary's duty to see that all stationery, blanks, and materials and any of the corporate books or documents in his keeping that may be needed at the meeting are at hand or readily accessible at the proper time. His preparations will also usually include: 1. ORDER OF BUSINESS. Unless the presiding officer is very familiar with the regular order of business as given in the by- laws of the company, a copy should be prepared by the secretary in convenient form for reference and be handed to the chairman at or before the time he takes charge of the meetings The object of the formal order of business is to insure the systematic and orderly conduct of meetings and of the business of such meetings. The order prescribed is, however, directory, not mandatory as are most of the by-law regulations, and may therefore be suspended at any meeting in whole or in part, either by a majority vote of those present or by their mere assent.io 2. LIST OF STOCKHOLDERS. Under the laws of New Jersey and some other states, an alphabetical list of the stockholders entitled to vote at the annual meeting must be prepared by the secretary, be presented at the meeting, and be kept 'there for the inspection of any stockholder. The requirement is a reason- able one, and a similar list will be found a convenience in any state. Its preparation is frequently made a by-law requirement. This list of stockholders is made out from the stock books after they are closed to transfers, and gives the names and addresses of the stockholders and the amount of stock held by each. It must be remembered, however, that the company's stock books are the final authority in any such matters and should be at hand for reference in case the accuracy of the list is impugned. 11 See Book IV, Form 65 (by-laws, Art. II, 6); also Form 66 (by-laws. Art. II, 5 9). Matter of Wheeler, 2 Abb. Pr. (N. S.) 361 (1866); Matter of Mohawk, etc., R. R. Co., 19 Wend. 135 (1838). Johnston v. Jones, 23 N. J. Eq. 216 (1872) ; Downing v. Potts, 23 N. J. L. 66 (1851). Ch. 42] ANNUAL MEETING OF STOCKHOLDERS 339 In the smaller corporations the secretary will in addition find an alphabetical list of the stockholders of much convenience for his own use. This list should be arranged with columns in which may be noted those present in person or by proxy, those absent, and the amount of stock held by each. 12 3. OUTLINE MINUTES. These will be found convenient for the ,use of the secretary. Properly prepared, they cover all routine business, so that a few short pencil notes will usually dispose of these matters, leaving the secretary free to attend to any new or special business that may demand his services. 13 398. Officers of Meetings No fixed rule prevails as to officers of stockholders' meetings. The regular officers of the company usually serve, but not unless authorized thereto by the charter or by-laws. If no such pro- vision exists, the stockholders elect or appoint the officers of their own meetings. As a rule, the secretary so appointed should be the secretary of the company. To appoint a secretary not familiar with the records, the personnel, and the general condition of the company, is apt to cause delay and confusion and is but seldom advisable. When the regular officers are designated, the president will take charge of the meeting as a matter of course, or in his absence the vice-president takes the chair. If both are absent, the treasurer might act as presiding officer. If the treasurer is also absent, the secretary might very properly ask someone present to call the meeting to order, who will then preside until a more permanent chairman is selected, or the secretary might act temporarily himself. If so, he should not preside longer than is necessary for the appointment of a chairman. He cannot act as president and secretary at the same time, and his more important duty is to record the proceedings of the meeting. In the absence of all the regular officers from the meeting, the " See Book IV, Form 160. " See Book IV, Form 161. 340 CORPORATE LAW [Bk. I- stockholders appoint a chairman and a secretary pro tern, who serve for that meeting. 399- Opening the Meeting Usually, as stated, the by-laws provide that the president and secretary of the company shall officiate at stockholders' meetings. In such case, at the appointed time and place the president, or in his absence the next ranking officer present, requests the meeting to come to order; and the secretary, if he has not already done so, furnishes the presiding officer with a copy of the order of business and presents a list of the stock- holders of the company which remains open during the meeting for the inspection of those present. 400. Roll-Call In the smaller corporations, the presiding officer after calling the meeting to order requests the secretary to call the roll. Practice varies as to the precise manner of roll-call. Usually the secretary employs an alphabetical list prepared for the pur- pose and, calling the names if he is not personally acquainted with all the stockholders, notes thereon those present either in person or by proxy, and any absentees.* 4 In the larger corporations this plan is not practicable. When the list of stockholders runs far up in the hundreds or thousands, an actual call of roll is obviously impossible. Instead, the chair- man first requests the stockholders present in- person to report to the secretary. As each reports, reference is made to the secre- tary's list of stockholders, and if the person reporting is found thereon, his name and the amount of stock he holds are recorded. The chairman then calls for those who represent stockholders by proxy. These also report, each giving the name of the stockholder and the number of shares he represents, handing in his proxy or, after exhibiting the original, a certified copy thereof, as evidence of his right to vote. The statements are verified See Book IV. Form 160. Ch. 42] ANNUAL MEETING OF STOCKHOLDERS 341 in each case, and the names of both principal and proxy and the stock represented are duly noted. In this way the number of shares represented and entitled to vote at the meeting is arrived at accurately and expeditiously. After the secretary has completed the roll-call or annotation of stockholders present, he announces to the chairman the total number of shares outstanding entitled to vote, the number neces- sary to constitute a quorum, the number represented at the meeting, in person and by proxy, and, if such is the fact, that they constitute a quorum. If a quorum is present, the presiding officer announces the fact and states that the meeting will proceed to business. If a quorum is not present and no other stockholders can be secured, the meeting may take either one of two courses. It may adjourn sine die, which defers the election of directors indefin- itely and leaves the existing board to hold over until the next annual meeting or until a special meeting is called for the election of directors; or the meeting may adjourn from day to day or, if the charter or by-laws so permit, to any desired future date, when if a quorum is secured the meeting may be held. The important point to be determined at roll-call is the amount of stock represented. The number of persons present is immaterial. One man, by stock ownership or proxies, or by both, might represent the entire outstanding stock of the com- pany, and such meeting, if properly conducted, is legal in this country. is In England it has been held that one person cannot hold a meeting. 16 In either country, however, the party in con- trol could avoid all question and satisfy every requirement by giving proxies for one or more shares of stock to convenient parties thus qualified to participate with him in the meeting. 401. Proxies A proxy is a special power of attorney executed by a stock- holder of the corporation and authorizing some specified person 16 Morrill v. Little Falls Mfg. Co., 53 Minn. 371 (1893); see note 21 L. R. A. 174. " Sharp v. Dawes, 2 Q. B. D. 26 (1876); In re Sanitary Carbon Co., 12 W. N. 223 (1877). 342 CORPORATE LAW [Bk. I to represent him at one or more stockholders' meetings of that corporation. A party who holds and exercises the powers of a proxy is said to act as a proxy. Any person competent to act as an agent may act as a proxy." The right to vote by proxy is not a common law right. It cannot therefore be exercised unless conferred either by con- stitutional provision as in the case in some states, by statute provision as is the case in many states, or otherwise by charter or by-law provisions. In the majority of states the statutes prescribe that voting at stockholders' meetings may be either in person or by proxy. In some states the statutes are merely permissive, allowing voting by proxy if provision therefor is made by charter or by- laws. Variations or restrictions of the usual right to vote by proxy are found in many states. Thus in New Hampshire no person may vote as proxy, or as principal and proxy, for shares exceeding one-eighth of the whole capital stock. In Maine a general power of attorney authorizing the voting of stock is good until it expires or is revoked, but a proxy must have been executed within thirty days preceding the day of meeting. In Pennsylvania a proxy must have been executed within two months of the date of meeting; in Massachusetts within six months; in New York, California, and Connecticut within eleven months; in Minnesota within one year; in New Jersey, Delaware, North Carolina, and Porto Rico within three years; and in New Mexico within five years. The original, or a duplicate or certified copy of every proxy should be filed with the secretary of the meeting at which the powers conferred by the proxy are to be exercised, and should be preserved by him in case the validity of the meeting or any of its proceedings should be questioned. If the proxy is a continuing one, it should be filed at the first meeting at which its powers are exercised but need not be filed at subsequent meetings. 17 See Book IV, Forms 127-133; also People's Bank v. Superior Court, 104 Cal. 649 (1894); Re Lighthall Mfg. Co., 47 Hun 258 (1888). Ch. 42] ANNUAL MEETING OF STOCKHOLDERS 343 402. Quorum A quorum at stockholders' meetings is the number of shares of stock which must be represented or the number of members which must be present to duly constitute the meeting and enable the legal transaction of business. In some of the states the statutes provide that at least a majority of the outstanding stock must be present in order to constitute a quorum. Else- where a similar provision is usually inserted in the charter or by-laws of the particular corporation. If no regulating provi- sions exist, the common law prevails, under which those present at a duly assembled stockholders' meeting are entitled to act, no matter whether they represent a majority of the outstanding stock or otherwise. "The law is clear that those stockholders who attend a duly called stockholders' meeting may transact the business of that meeting, although a majority in interest or in number of the stockholders are not present." 18 In the absence of conflicting statutes, the stock necessary to constitute a quorum may be fixed at any amount desired. The usual and best practice requires a majority of all the outstanding stock. A smaller quorum is sometimes prescribed but is not always safe. A majority of a legal quorum may always act. Hence, if less than a majority constitutes a quorum, it is entirely possible that matters of the greatest importance to the cor- poration will be decided by less than one-fourth of the outstand- ing stock. It may be noted that the statutes of a few states New York among them reaffirm the common law as to a quorum in the case of meetings for the election of directors. 19 In these states the stockholders, meeting at the duly appointed time and place for the election of directors, have power to act regardless of the amount of stock they represent, that is, whether or no a quorum is present. 20 18 Cook on Corp., I 607; Morrill v. Little Falls Mfg. Co., S3 Minn. 371 (1893). Stock Corp. Law (N. Y.) , f 25. 10 See i 170; also Matter of Rapid Transit Ferry, 15 App. Div. (N. Y.) 530 (1897). 344 CORPORATE LAW [Bk. I- 403. Proof of Notice After the presence of a quorum has been ascertained, the secretary, in response to a request from the chair, should submit proof that due notice of the meeting has been given. For this purpose a copy of the notice should be exhibited, with the secretary's certificate as to its due service attached. If greater formality is desired, the secretary's certificate might appear in the form of an affidavit. When less formality is deemed suffi- cient, the secretary merely presents a copy of the notice with a statement that it has been sent out as required by by-laws. 21 If notice by publication has been given, the secretary should exhibit copies of the papers containing the notice, or copies of the notice with the affidavit of the publisher or of the secretary himself as to its publication. If the formality of an affidavit is deemed unnecessary, the secretary's certification, or even his mere statement, as to the facts of publication will usually suffice. 404. Reading of Minutes 22 The presiding officer next calls for the reading of any unap- proved minutes. The secretary in response reads the minutes of the annual meeting held the preceding year, also the minutes of any special meeting or meetings of the stockholders held during the year. Occasionally it will happen that the reading of the minutes at the preceding annual meeting has been passed or the minutes of preceding meetings have not been approved at such meeting, and the secretary will then go back still further, pre- senting all minutes of stockholders' meetings that have not been read and approved at some succeeding meeting. At the close of the reading of each set of minutes or, if pre- ferred, at the close of the reading of all unapproved minutes, the chairman may announce: "If there are no objections, the minutes as read will stand approved"; or a motion may be passed that "the minutes be approved as read." " See Book IV, Forms 221-223. 22 See Book IV, Form 168. Ch. 42] ANNUAL MEETING OF STOCKHOLDERS 345 If errors are discovered, the minutes may be corrected at once or when the reading of the particular minutes is concluded, or at any time previous to their approval. If the errors are obvious or immaterial, the presiding officer may, in the absence of objection, merely direct the secretary to make the corrections. If there is any question as to an alleged error or if the matters are important, the correction of the minutes is best effected by motion. If the motion prevails, the minutes must be amended accordingly and are then "approved as corrected," usually by order of the president or chairman; otherwise by formal motion. The minutes of an annual or special meeting cannot be approved at a special meeting of stockholders unless so specified in the call for such meeting. Minutes of a directors' meeting are never read at a stockholders' meeting, except for purposes of information or to obtain the stockholders' ratification of acts recorded in the minutes. The reading of the minutes may be dispensed with, if desired, either by formal motion or, in "the absence of objection, by mere announcement of the chairman. 405. Annual Reports 23 Under the usual order of business the annual reports of officers and committees follow the reading of minutes. The president's report is the first official report to be presented. Following this usually comes the treasurer's report, and if other officers have reports to make or if the board of directors or any committees have reports to submit, they are in order at this time. Before a report presented at the annual meeting is formally received, it is discussed if necessary and any desired questions asked and answered concerning it. A motion is then made that the report be received and filed, or otherwise disposed of as may be necessary; or in the absence of objection, its proper disposition may be effected by order of the chairman. If any report proves See Book IV. Ch. XXVII. "Reports." 346 CORPORATE LAW [Bk. I- to be incomplete, erroneous, or otherwise objectionable, a motion may be made to return such report for correction or for revision, or it might even be rejected absolutely, such rejection serving as an emphatic rebuke to the official or committee by whom the report was made. As reports are ordered received, the secretary, unless it is expressly otherwise ordered, takes charge of and preserves them for future reference. Reports of special importance are some- times ordered spread upon the minutes, or entered in the minute book immediately following the minutes of the meeting. 406. Election of Directors In the larger corporations the annual election of directors is the most important event in the corporate calendar, deciding the management and the general policy of the company for the ensuing year. In small or close corporations, on the other hand, the election of directors is frequently omitted, the directors then in office holding over for another year or until their successors are elected. There is no legal objection to this practice when all the stockholders acquiesce. Voting for election of directors should be by ballot. 24 In perhaps the majority of the states the statutes require this method to be followed. The election is usually conducted by inspectors or tellers, in some states as a matter of statutory re- quirement; elsewhere as a matter of by-law provision or merely of convenience. These inspectors or tellers, usually two in number, may be stockholders or otherwise, as seems best to the meeting, but candidates who are to be voted upon at the election should not be appointed. The inspectors take entire charge of the election. At its close they announce the results, or otherwise hand their report to the chairman of the meeting, who reads the results from the inspectors' report. The report is then handed to the secretary for preservation or for such other disposition as may be prescribed. 24 See Book IV. Forms 166, 167. Ch. 42] ANNUAL MEETING OF STOCKHOLDERS 347 In the larger corporations the formalities of an election of directors are usually strictly observed. In the smaller corpora- tions such elections are frequently conducted very informally. Where there is entire agreement, the board is sometimes selected by conference, and the secretary authorized thereto by motion casts the single ballot of the meeting for the parties named. Unless otherwise provided by statute or the charter or by- laws of the corporation, a majority of the votes cast at an election of directors held at a duly constituted meeting elects, 25 even though these are not a majority in interest of all those pres- ent at the meeting. In other words, stockholders who do not vote cannot have their votes counted in the negative. 26 The charter or by-laws may, however, in the absence of any con- flicting statutes, modify this rule by providing that the votes of a majority of those present at the meeting, or of a majority or any other desired proportion of the outstanding stock, shall be necessary to elect. If less than the full number of directors to be elected receive the majority or plurality vote necessary to elect, those receiving the required majority or plurality vote are elected and another ballot or another election may be held to elect the remainder. 2 ' It may be noted that unless the statutes, charter, or by-laws provide that a plurality of votes elect, a majority of all the votes cast is necessary to an election. 28 After the ballot has been counted or announced, it is too late to receive additional votes. 407. Voting at Elections If the statutes do not prescribe the method of voting at elections of directors, it may be by any desired method that will fairly indicate the will of those entitled to vote. The stock books of the corporation which show the transfer and ownership of stock are in most states the final and decisive * 2 Cook on Corp.. 5 608. State v. Green. 37 O. St. 227 (1881); Smith v. Proctor, 130 N. Y. 319 (1891). 27 Wright v. Commonwealth, 109 Pa. St. 560 (1885). 28 i Thompson on Corp., } 846; 2 Cook on Corp., { 608. 348 CORPORATE LAW [Bk. I- evidence as to who is entitled to vote at corporate elections. If the corporation keeps no other stock book than a stock certificate book, this will be sufficient if it shows the stock transfers and ownership. A stockholder cannot be kept from voting on account of the loss or absence of his stock certificate ; nor can he be denied the voting right because his stock is not fully paid, unless it is expressly so provided by the statutes of the state or the charter of the corporation. 29 A by-law provision restricting the voting right is not ordinarily effective. A corporation can- not vote on its own stock, whether held in the name of the corporation or a trustee for the corporation. Any sale or issue of stock made by the directors to control an election can usually be stopped by injunction, or the courts may be invoked to set the election aside. The inspectors, tellers, or other officers conducting an election have no authority to refuse the vote of any stockholder of record, nor the right to receive the vote of anyone who is not a stock- holder of record. Even when grounds for so doing exist, the courts alone can go behind the corporate records and enjoin stockholders of record from voting, or set aside an election carried by the vote of such stock. The secretary or chairman of the meeting has no authority to decide who may vote, the matter resting with the tellers or other persons conducting the election, who must be governed by the stock books of the corporation. Under the general rule in regard to voting at elections, a stockholder is entitled to one vote for each director to be elected, for each share of stock standing in his name on the books of the corporation. 3 If there are any variations of this usual rule, such as cumulative voting, classified voting, or restriction of voting to one class of stock, such variation should be stated as clearly as possible in the charter or by-laws of the corporation ' Downing v. Potts, 23 N. J. L. 66 (1851); People v. Albany, etc., R. R., 55 Barb. (N. Y- 344, 386 (1869); Am. etc., Co. v. State Board, 56 N. J. L. 389 (1894). 10 2 Cook on Corp., I 609. Ch. 42] ANNUAL MEETING OF STOCKHOLDERS 349 and must, as a matter of course, conform to the requirements of any state statutes on the subject. 408. Cumulative Voting The usual method of voting for directors results in the elec- tion of the entire board of directors by those holding a majority of the stock. The cumulative system of voting is a modification of this usual method whereby representation on the board may be secured by the minority. Under it, while each share still has as many votes as there are directors to be elected, and these votes may be cast one for each candidate as before, all of these votes, if so desired, may be cast for one candidate or may be divided among any or all of the candidates a3 the stockholder sees fit. Thus if five directors are to be elected, a stockholder owning one share of stock may, under the cumulative system, cast one vote for each of five candidates or, if he prefers, may cast five votes for one candidate, or two votes for one and three for another, or divide his five votes among the candidates in any other way he sees fit. The practical result of this modification of the usual system is to insure minority representation whenever the minority holding of stock is at all material. 31 409. Other Business The consideration of any unfinished business follows the election of directors. This includes any matters which were under consideration but not disposed of at any prior stock- holders' meetings, whether regular or special. Matters referred to committees for consideration or investigation or report come under this head and may be acted upon at this time. The secretary usually brings up any matters of unfinished business, but the stockholders or the chairman himself may properly call them to the attention of the meeting. H This subject is treated more fully in Ch. VLIII, "Protection of Minority Stockholders." 350 CORPORATE LAW [Bk. I- If there is no unfinished 'business, or otherwise upon its disposal, the presiding officer passes on to the next order of busi- ness and inquires if there is any new business to be brought before the meeting. Under this head come any matters requiring the attention of the meeting not before considered. These may be brought up either by the officials of the meeting or by any of the stockholders present. 410. Adjournment After the disposal of any new business brought before the meeting, adjournment is in order. This may be by motion. Usually, however, when this point is reached the chairman inquires if there is any other business before the meeting and, if no response is received, declares the meeting adjourned. Such adjournment is sine die, i.e., final. If the business of the meeting cannot be 'completed at the one session, or if any other reasons render its continuation desir- able, it is not adjourned sine die, but to such convenient future date as may be decided upon. An adjournment of this kind is usually by motion, but if it is obviously desirable or advisable, the chairman might properly adjourn the meeting himself, merely announcing: "If there is no objection, the meeting stands adjourned until . . . ' Adjournment may be made only by consent of a majority of those present, and the chairman has no power to declare a meet- ing adjourned in defiance of this majority. If he does so not- withstanding, any stockholder may demand a vote, and, if this vote is against adjournment or if the chairman should decline to put the matter to vote, a majority of the stockholders may remain and continue the meeting, electing a new chairman if necessary, and even adjourning to another room. 32 If the meeting adjourns to a date certain, the adjourned meeting is regarded as a continuation of the original meeting and need not therefore be again notified to the stockholders. If State v. Cronan, 23 Nev. 437 (1897). Ch. 42] ANNUAL MEETING OF STOCKHOLDERS 351 the adjournment is for more than a few days, however, it is always proper for the secretary to send out notice of the ad- journed meeting a reasonable time before it convenes. As an adjourned meeting is, from a legal standpoint, merely a continuation of the original meeting, the same officers preside and any business that might have been transacted at the first meeting may be acted upon at its adjournment, or at any adjournment from an adjourned meeting. 33 411. Signing Minutes As soon after the meeting as convenient and while its details are fresh in his mind, the secretary should write up its proceed- ings in the minute book and sign them with his name and official designation. The presiding officer also usually affixes his sig- nature. The minutes are the legal evidence of the proceedings of the meeting, and this double signature is of advantage in event of any dispute as to the accuracy of the record. 34 33 People v. Batchelor, 22 N. Y. 128 (1860); Staats v. Borough of Washington, 44 N. J. L. 605, 611 (1882). 54 See Book IV, Ch. XVI, "Minutes of Corporate Meetings." CHAPTER XLIII SPECIAL MEETINGS OF STOCKHOLDERS 412. Special or Called Meetings "Special" or "called" meetings are held when matters de- manding the attention of the stockholders arise in the interim between annual meetings. As in the case of annual meetings, special meetings of stockholders must be held within the state in which the corporation was organized, and usually at the principal office of the corporation, unless otherwise expressly permitted by statute or charter provision. Statutory provisions regarding special meetings which are found in a number of states, mainly relate to the call or notice required. Special meetings differ from the annual meeting in the fol- lowing important details: 1. They must be authorized by a more or less formal call. 2. Notice of the time, of the place, and of all business to be transacted at the meeting must be given each stockholder of record. 3. No other business save that so notified may be trans- acted at the meeting. The formalities of special meetings must be strictly observed, or action taken thereat may be invalidated. They may, how- ever, be waived by consent of every interested party, either formally expressed in writing, or indicated by their presence at, and participation or acquiescence in, the meeting. 1 413. Call for Meeting The time and place of special meetings cannot, from the nature of the case, be prescribed by the by-laws, and hence See Book IV, Form 105. 352 Ch. 43] SPECIAL MEETINGS OF STOCKHOLDERS 353 each meeting must be formally called as the necessity arises. The manner of this call is sometimes prescribed by statute or charter but is usually left for the by-laws. If neither the stat- utes, charter, nor by-laws prescribe the manner of calling special meetings of stockholders, the directors may always do so by resolution, 2 or the stockholders may unite in calling a meeting, which, provided the number joining in the call represents a fair proportion of the outstanding stock and the time and place is reasonable, will be legal. Ordinarily the by-laws provide that special meetings may be called in any one of four ways: 1. By written call signed by the president. 2. By resolution of the directors. 3. By written call signed by two or more directors. 4. By written or published call subscribed by a specified number of stockholders, or a certain proportion of the outstanding stock, usually ranging from one-third to a majority. 3 The call and notice for a special meeting must state its time, place, and purpose. 4 These essentials every stockholder is en- titled to know, and the omission of any one might invalidate the entire action of the meeting. No business except that which has been specified in the call and in the notice which follows the call, can be legally transacted at a special meeting. 5 To end the call or notice, as is frequently done, with some general phrase, such as "and all other matters that may come before such meeting," does not add to the scope of the meeting in any way and does not in itself legally authorize the consideration of anything. 6 Where a company with but few stockholders is to be assem- bled in special meeting, tune may be saved by employment of the combined call and waiver of notice. This requires the sig- J Commonwealth v. Smith, 45 Pa. St. 59 (1863); Cassell v. Lexington, etc., Co., 9 S. W. Rep. 502 (1888). See Book IV, Ch. XI, "Calls and Waivers for Special Meetings." 4 2 Cook on Corp., { 595. 6 Clark & Marshall on Corp., i 647. i Morawetz on Corp., 5 482; People's Ins. Co. v. Westcott, 80 Mass. 440 (1860). 354 CORPORATE LAW [Bk. I- nature of every stockholder to make it effective, but the meet- ing so authorized may be held at once, and, if so agreed, any business within the powers of the stockholders may be trans- acted .thereat. A provision in a duly signed call and waiver for the "transaction at such meeting of any and all business pertaining to the affairs of the company" is effective, since everyone interested has agreed thereto. 7 The first meeting of stockholders is merely a form of special meeting and is usually assembled by call and waiver signed by all those entitled to be present. 414. Notice of Special Meeting The call for a special meeting must not be confused with the notice of such a meeting. The call is the written authority or instructions, usually handed or sent to the secretary, pursuant to which the meeting is to be assembled. The notice, on the other hand, is the actual statement of the time, place, and pur- poses of the meeting, sent out to the stockholders, usually by the secretary, in obedience to the instructions of the call and in accordance with its terms. 8 If there is any material differ- ence as to these between the call and the notice, the meeting is invalidated thereby. The time means both the day and the hour. No business other than that specified in the notice may be transacted at a special meeting. If one single stockholder is not properly notified, he may be able to set the entire pro- ceedings of the meeting aside. 9 When, as is usually the case, notice of a special meeting must be sent by mail to the "last known address" of each stock- holder, or to his "address as it appears on the books of the corporation," the secretary must be prepared to make affidavit, if necessary, that this has been done. If no special method of service or publication is prescribed by the statutes, the by-laws, 7 2 Cook on Corp., 599. 8 i Morawetz on Corp., 5 482. See Book IV, Ch. XII, "Notices of Meetings." Ch. 43] SPECIAL MEETINGS OF STOCKHOLDERS 355 or other corporate regulation, the secretary must himself or by deputy give personal notice by placing a copy of the notice in the hands of each stockholder. 10 If no time is prescribed, notice must be served a "reasonable time before the meeting." 11 When notice is requested to be given a certain number of days before the meeting, the time should be counted exclusive of the day of notice and the day of meeting, though in New York by statute provision but one of these days need be excluded. If the secretary refuses to give proper notice of a special meeting after it has been duly called, anyone interested may send out the notice, and such notice, if in due form and properly served on each stockholder, will be effectual. 415. Consent Meetings Special meetings of stockholders may be assembled at any time without the usual call and notice if all interested sign a formal waiver thereof. 12 Also, if without any such waiver all the stockholders assemble in meeting, no matter how called or whether called at all, it is termed a "consent meeting," and, all present acquiescing, any business within the stockholders' powers may be transacted thereat. 13 Those present and participating in such meeting are thereby estopped from later objection to any informality of call or notice, and, as all concerned are present, no one is left who has a right to object. When consent meetings are held, it is important that the minutes shall show the presence of every stockholder. Also if the action taken is important, it is always advisable that every person present shall either sign the minutes, which is the most effective evidence of attendance and acquiescence, or otherwise sign a waiver of the formalities. In a small or close corporation consent meetings can be 10 Stebbins el al., Admrs. v. Merritt el al., 64 Mass. 27 (1852); Tuttle v. Mich. Air Line R. R. Co., 35 Mich. 247 (1877). 11 Re Long Island Railroad, 19 Wend. (N. Y.) 37 (1837); Covert v. Rogers, 38 Mich. 363 (1878). 12 3 Clark & Marshall on Corp., } 647, note 278. " Handley v. Stutz, 139 U. S. 417 (1890); In re Griffing Iron Co., 63 N. J. L. 168 (1898); affd., 63 N. J. L. 357 (1899). 356 CORPORATE LAW [Bk. I- readily assembled and are the rule when special meetings are necessary. In the larger corporations such meetings are in most cases obviously impossible. In New York and a few other states such "consent meetings" are recognized by statute law. Elsewhere such a meeting is valid under the common law. 416. Opening Formalities The procedure for opening a special meeting is the same as in the case of the annual meeting. 14 The alphabetical list of stockholders required by statute in some of the states at the annual meeting of stockholders, is not required at special meet- ings unless directors are to be elected. The proof of proper call and notice of the meeting follows .the roll-call. The secretary should present the original duly signed call; also a copy of the notice sent out pursuant to the call, with his certificate attached showing that the notice was properly addressed and mailed to each stockholder the neces- sary number of days before the date of the meeting. The call and notice may be ordered received and filed as in the case of a regular meeting, or, as the validity of the meeting is dependent upon its due assembling evidenced by the call and notice, they may very properly be ordered spread upon the minutes. If the meeting has been assembled by call and waiver signed by all the stockholders of the company, this instrument should be presented to the meeting and may be properly included by the secretary in his minutes without instruction. 417. Special Business Minutes of previous stockholders' meetings cannot properly be approved at a special meeting, unless so provided in the call and notice or other authorization of the meeting, nor can any other business be transacted save that so specified. 15 Hence the particular business for which the meeting was called should 14 See $ 399- "Warner v. Mower, n Vt. 385 (1839); People's Mut. Ins. Co. v. Westcott, 80 Mass. ^o (1860); Atlantic De Laine Co. v. Mason, 5 R. I. 463 (1858). Ch. 43] SPECIAL MEETINGS OF STOCKHOLDERS 357 be taken up at once. The presiding officer, or at his request someone present, states the purposes of the meeting and makes such explanations as may be necessary. Or the presiding officer may call upon the secretary to read the notice of the meeting in which its purposes are set forth and then call upon someone familiar with the matter to explain it to the stockholders. After such statement and explanation and any desired discus- sion, someone interested usually presents and moves the adop- tion of a resolution covering the matter. The meeting may then, at its discretion, dispose of this resolution in any parlia- mentary way. 418. Adjournment As already stated, no business of any kind may be transacted at a special meeting save that specifically authorized. As soon, therefore, as the particular business for which the meeting was called is disposed of, nothing is left but adjournment. This may be by motion, or, if no one objects, the president may merely state that "no further business being before the meeting, it stands adjourned." A special meeting may be adjourned to another day just as may an annual meeting, and at the adjourned meeting any business set forth in the notice for the original meeting may be considered. New business cannot, however, be introduced or considered. No notice of an adjourned meeting is necessarily sent to stockholders. CHAPTER XLIV MEETINGS OF DIRECTORS 419. Time of Meeting The by-laws usually set forth the general details of directors' meetings. The board itself may provide for any details not already prescribed by some competent authority. Special meetings of directors are called when the necessity arises. Regular meetings are held at specified times commonly once a month usually fixed by the by-laws. In the smaller corporations with boards consisting of a few members easily assembled in special meeting, and also in the larger corporations whose affairs are conducted mainly by standing committees, regular board meetings once a quarter, or even at longer intervals, are usually sufficient. 420. Place of Meeting The usual place for meetings of directors is the principal office of the corporation in the state of its creation. Directors' meetings may, however, be held elsewhere, either within the state, 1 or without the state in the absence of prohibition, 2 if properly authorized by the charter, the by-laws, or by due resolution of the directors. If prohibited by statutes, charter, or by-laws, meetings outside the state are void, and their actions of no effect. 3 In a majority of the states the statutes provide that directors' meetings may be held outside the state if authorized in some specified manner usually by the by-laws, in some states by 1 Corbett v. Woodward, 5 Sawy. 403 (1879); Ashley Wire Co. v. 111. Steel Co., 164 111. 149 (1896). 2 3 Cook on Corp., { ?i3a; Saltmarsh v. Spaulding, 147 Mass. 224 (1888). * Brockway v. Gadsden, etc., Co., 102 Ala. 620 (1893); Union Nat. Bk. v. State Bank, 155 Mo. 95 (1899)- 358 Ch. 44] MEETINGS OF DIRECTORS 359 the charter, in others by either, but in one or two states by mere resolution of the directors. In New York meetings of directors may be held outside the state unless otherwise expressly provided in the charter or by-laws. * Other provisions affecting directors' meetings outside the state are found in a number of states. In the absence of any statutory provision on the subject, it is generally held that directors may hold meetings and transact business outside the state of incorporation. 5 In New York a contrary ruling was made, but it is now provided by statute that if meetings of the board of directors of a corporation organ- ized under the Business Corporation Law are to be held only within the state, the certificate of incorporation or by-laws must so provide. 6 Of course, if prohibited by statute, meetings of the board of directors cannot be held outside the state, and action taken at such meetings will be void. 7 Permission for directors' meetings outside the state is given by the statutes of several of the states besides New York, and, used under proper regulations as to place and notice, such meetings are at times of much advantage. When directors are especially authorized to meet outside of the state there is of course no question as to the legality of their actions at such meetings. 8 421. Purposes of Meetings At duly assembled regular meetings of directors, any busi- ness within the power of the board may be transacted. At special meetings, unless otherwise agreed by every member of the board, only such business may be acted upon as is set forth in the call and notice of the meeting. If, however, the notice of a special meeting does not specify its purposes, any ordinary 4 N. Y. Bus. Corp. Law, | 2. 'Handley v. Stutz, 139 U. S. 417 (1891); Boatmen's Bank v. Gillesple, 209 Mo. 217. 256 (1908). N. Y. Bus. Corp. Law. | 2. 7 Hilles v. Parrish, 14 N. J. Eq. 380 (1862); Place v. People, 192 111. 160 (1901). ''Siltmarsh v. Spaulding, 147 Mass. 224 (1888); Ormsby v. Copper Co., 56 N. Y. 623 (1874). 360 CORPORATE LAW [Bk. I- business affairs of the corporation may be transacted thereat, unless the by-laws specifically provide that only such business as has been duly notified may be transacted at special meetings of the board. 422. Assembling Meetings The time and place of regular meetings are usually prescribed in the by-laws, are supposed to be known to the directors, and do not depend for their legality upon calls, waivers, or notices.a Notices are, it is true, generally provided for in the by-laws, but this is a practical measure to insure the attendance of direc- tors, and is not in compliance with legal requirements. To pre- vent any question on this point, nowever, the by-laws of the larger corporations customarily provide that failure to send out notice of a regular meeting shall not affect its legality nor the legality of any action taken thereat. Special meetings, on the other hand, are assembled as the necessity arises, must be called by proper authority, and must be formally notified. to every member of the board, unless these formalities are duly waived. Accordingly special meetings of the board are assembled by means of the call followed by notice, or by means of a combined call and waiver of notice. Or if all the members of the board can be gotten together, a special meeting may by agreement be held at any time and without formality. These methods of assembling meetings of directors are discussed in the sections which follow. 423. Call for Special Meetings The call for a special meeting of directors is the formal in- strument which authorizes its assembling, specifying its time, place, and purposes, and usually directing or otherwise obligat- ing the secretary to notify such meeting to the members of the board. 10 Whitehead v. Rubber Co.. 52 N. J. Eq. 78, 82 (1893); Western Imp. Co. v. Bank, 103 Iowa 455 (1897); Atlantic, etc., Co. v. Sanders, 36 N. H. 252 (1858). "See Book IV, Ch. XI. "Calls and Waivers for Special Meetings." Ch. 44] MEETINGS OF DIRECTORS 361 In some few states the statutes prescribe by whom special meetings of directors may be called. In the majority of the states the matter is left entirely for by-law regulation. These almost invariably empower the president to call special meetings, usually alone, but sometimes in conjunction with some other officer. Usually they provide that two or more of the directors may call such meetings. Occasionally a certain proportion in interest of the stockholders are authorized thereto. Whether so specified in the by-laws or not, special meetings of directors may always be called by due resolution of the board. Consent meetings are assembled informally. The call for a special meeting of directors by whomsoever issued, to be legally effective, must always specify the time of meeting and its place, and if business of special importance is to be considered this must also be set forth. The place is usually though not necessarily unless so .specified by statute or by-laws the principal office of the corporation within the state of incorporation. 11 In the absence of conflicting provisions, special meetings may be called to meet at any reasonable place in the discretion of the party or parties issuing the call. The time at which the meeting is to be held must be reason- able, and must be definitely stated, both day and hour being given. The particular business to be transacted must be specified with reasonable detail, and ordinarily no other business may be transacted at such special meeting. 424. Notice of Special Meetings When a call in due form for a special meeting of directors is handed to the secretary, it is his duty to send out notices of the meeting thereby authorized. These notices are sent in such manner usually by mail or telegraph and at such time before the meeting as is prescribed by the by-laws, or otherwise as 11 See 5 420. 362 CORPORATE LAW [Bk. I- will under ordinary conditions permit the attendance of all the members of the board. 12 The by-laws also frequently prescribe that no business save that specifically set forth in the call and notice shall be con- sidered or acted upon at such special meetings. If not so pre- scribed, a notice specifying time and place, but not the business to be transacted, is sufficient to authorize all ordinary corporate business. 13 It is otherwise if important or unusual business is to be transacted at the special meeting. In a Pennsylvania case the notice read: "To hear report of Treasurer and such other business as may be brought before the meeting." A quo- rum of the directors met and authorized an important lease. This the courts set aside. 14 When the by-laws do not prescribe the specific details of notice, both its time and manner must be reasonable. Just what constitutes reasonable notice of special meetings of direc- tors is a matter on which judicial decisions vary, and should therefore be settled by express by-law provision. It is always presumed that notice duly mailed with postage prepaid to the last known address of each member of the board is received by the party addressed. It is, however, usually provided in the by-laws that notice given in this manner shall be sufficient. When this is done, it is immaterial whether or not the notice is actually received. 15 Notice by postal card is sufficient when this method of notification is customary. Any irregularity in call or notice may be cured by a ratification of the special meeting or of the business transacted thereat at a subsequent regular meeting of the board, or, if all the members are present at and participate in a special meeting, this in itself cures any defect in call or notice. 16 Unless cured in some way, 12 See Book IV, Forms 125, 126; also People v. Albany Medical College, 26 Hun (N. Y.) 348 (1882); Ashley Wire Co. v. Illinois Steel Co., 164 111. 149 (1896); Stockton, etc., Works v. Houser, 109 Cal. i (1895). In re Argus Co., 138 N. Y. 557 (1893); Ashley Wire Co. v. Illinois Steel Co., 164 111. 149 (1896). " Mercantile Library Hall Co. v. Pittsburg, etc., Assoc., 173 Pa. St. 30 (1896). Ashley Wire Co. v. Illinois Steel Co., 164 111. 149, 159 (1896); Haj v. Amer. Bottle Co., 182 111. App. 636, 641 (1913). 11 Minneapolis Times Co. v. Nimocks, 53 Minn. 381 (1893); Chase v. Tuttle, 55 Conn. 453 (1888). Cli. 44! MEETINGS OF DIRECTORS 363 failure to give notice to any one director invalidates the action of a special meeting. 17 425. Call and Waiver of Notice The call and waiver of notice of a special meeting of directors is merely a call for the meeting combined with a waiver of the usual formalities of notice. This must be signed by every member of the board, but when so signed authorizes a meeting to be held at the time and place, and for the transaction of the business specified therein. Whenever the members of the board are readily accessible, the call and waiver is the preferable method of assembling special meetings. 18 426. Opening Directors' Meetings At the time appointed for the meeting, the president of the corporation or the chairman of the board, if such official exists or in his absence the vice-president, calls the meeting to order. Should these officers be absent, the next ranking officer of the corporation, if a member of the board, presides. Should such officer be the secretary, he should merely call the meeting to order, and then request some other member of the board to act as chairman, or, if objection is made, the appointment should be effected by motion. If no officer of the corporation who is also a member of the board is present, it is proper for any member of the board in attendance to call the meeting to order, and in the absence of objection ask someone to act as chairman. If there is objection, the appointment should be made by means of a motion. No formal roll-call of a directors' meeting is usual, the sec- retary merely noting the names of those present, which names are later entered on the minutes. If there is no quorum, business may not be transacted at that session, but the meeting may adjourn from day to day, if desired, until a quorum'is secured. "People v. Batchelor, 22 N. Y. 128 (1860); Relley v. Campbell, 134 Cal. 175 (1901); Broughton v. Jones, 120 Mich. 462 (1899); Hill v. Coal Co., 119 Mo. 9 (1893). "See Book IV, Forms 116, 117. CORPORATE LAW [Bk I- Formal submission of proof of notice of a directors' regular meeting is not necessary unless called for by 'the president or some member of the board. The secretary should, however, preserve a copy of the notice sent out and indorse upon it the fact that it was duly mailed on the date given thereon to the last known address of each member of the board. In the case of special meetings of directors the call and notice, or call and waiver of notice as the case may be, should be submitted to the meeting and be entered on the minutes in full with a statement of the circumstances. The matter is of importance, as the due call of the meeting with sufficient notice to each member is absolutely essential to its legality. At a regular meeting of directors the order of business as set forth in the by-laws is followed, unless set aside by formal motion or unanimous consent. At a special meeting it is but seldom applicable. 427. Quorum The number required for a quorum at directors' meetings should be fixed by the charter or by-laws. 19 In New York this cannot be a number less than one-third of the full 20 membership of the board. Where there is no provision in the charter or by-laws, the common law prevails, and a majority of the whole board is necessary for a quorum. 2 A majority of the board in this connection is a majority of the whole number constituting the board, and not of some reduced number resulting from vacancies or removals. 22 A majority of a quorum can decide any question properly brought before the meeting. 23 Directors cannot vote by proxy at directors' meetings, but must be personally present in order to act thereat. 24 No legal 19 Hoyt v. Thompson's Ex... 19 N. Y. 207 (1859); Craig Medicine Co. v. Merchants' Bank, 59 Hun (N. Y.) 561 (1891). 80 N. Y. Gen. Corp. Law, 34. 21 Wells v. Rubber Co., 19 N. J. Eg. 402 (1869). 21 Moore v. Rector, 4 Abbott's N. Cas. (N. Y.) 51 (1873). a N. Y. Gen. Corp. Law, J 43; Wells v. Rubber Co., 19 N. J. Eq. 402 (1869); Foster v- Mill Co., 92 Mo. 79 (1887). 24 Perry v. Oil Co., 93 Ala. 364 (1890); State v. Perkins, 90 Mo. App. 603 (1901). Ch. 44] MEETINGS OF DIRECTORS 365 authority exists for permitting directors to vote or to be con- sidered as present when merely connected by telephone, nor for permitting an absent member to sign the minutes of the direc- tors' meeting and be counted present, though any action so taken may be validated by action at a subsequent meeting where a quorum is really present. A director cannot legally vote at directors' meetings on a matter in which he is personally interested, nor is such action usually valid if he is counted to make a quorum when such a question is put to vote. 25 428. Reading the Minutes As a matter of due parliamentary procedure, any unapproved minutes of preceding directors' meetings should be read and approved or be otherwise disposed of at a regular meeting of directors before any other business is considered. If, however, time is pressing, the president sometimes directs that the read- ing of the minutes be dispensed with, or the same end is accom- plished by formal motion. The minutes of stockholders' meetings are never read at directors' meetings unless as a matter of information or by special request, nor if read would their approval by the board be of any legal effect. The minutes of any preceding board meeting should not be approved at a special meeting unless the approval of such minutes was specifically mentioned as one of the purposes of the meeting. 26 429. Reports At a regular meeting, after disposal of the minutes, the president takes up the next order of business and calls for re- ports from officers first, and then from committees, if any are to report. When a report is made it may be disposed of by motion, or, if there are no objections, the president himself may direct K Curtin v. Salmon River Co., 130 Cal. 345 (1900); Miller v. Crown Perfumery Co., 57 Misc. (N. Y.) 383 (1908); Jacobson v. Brooklyn Lumber Co.. 184 N. Y. 152 (1906). * See f 438. 366 CORPORATE LAW [Bk. I- that the report be received and filed. A verbal report does not require any formal disposal, the secretary reporting its sub- stance in the minutes as a matter of course. 430. Unfinished and New Business The business of a special meeting is, as a rule, all new busi- ness. It is set forth in both the call and notice, and may be presented by the presiding officer, or he may call on the secretary or some member of the board for its introduction. At regular meetings of directors it usually rests with the secretary to bring up any matters of unfinished business. New matters requiring attention are brought up by the president or by any member interested. The election of officers does not appear upon the regular order of business, as it takes place but once a year. It therefore comes under the head of "New Business," and at the proper meeting may be taken up at any suitable time when new busi- ness is under consideration. Usually the by-laws provide that the election of officers shall be held at the first directors' meeting after the annual meeting of stockholders. Officers are usually elected by ballot, though in the absence of express provision the board may follow any method that will secure a fair expression of the wishes of its members. When the board is agreed as to who are to be elected, time is frequently saved by instructing the secretary to cast the single ballot of the meeting for the recited list of officers. Or a mere motion unanimously carried that the named persons be respectively appointed to the specified offices, is legally suffi- cient. The election of officers by the board is sometimes held to be more in the nature of an appointment than of an election. 27 Unless otherwise specified by the by-laws or prevented by conditions, the officers-elect may at once begin the discharge of the duties of their respective offices. Frequently the newly 27 State v. Kupferle, 44 Mo. 154 (1869). Ch. 44] MEETINGS OF DIRECTORS 367 elected president and secretary take charge of the meeting im- mediately after the result of the election has been announced. A person cannot be made an officer against his will.28 Ac- ceptance of the position to which an officer-elect has been ap- pointed is therefore necessary. This may either be expressed, or be indicated by the performance of the duties of his office, or even by his failure to decline the office when properly notified of his election thereto. 29 431. Adjournment When the business of a meeting has been finished, or when for any reason the board cannot longer continue in session, an adjournment should be taken, either sine die, which terminates the meeting absolutely, or, if important business is left un- finished, to some specified future date. A meeting adjourned to some future time is on reassembling legally regarded as a continuation of the original meeting, may transact any business that could have been transacted at the original meeting, and does not necessarily require any notifica- tion to the members of the board. 30 432. Procedure at Meetings of Standing Committee The general rules governing the meetings of a standing com- mittee are the same as those for meetings of the board. 31 Special meetings must be duly notified to every member of the committee unless waived by formal agreement or by the presence of every member at the meeting. Actions taken at meetings of the com- mittee should be expressed by means of duly adopted motions or resolutions, and careful minutes of all proceedings should be kept in a minute book provided for the purpose, and not in the minute book of the directors. The committee proceedings should "Blake v. Bayley, 82 Mass. 531 (1860). " Danville, etc., Co. v. Brown, 90 Va. 340 (1893); Lockwood v. Nat. Bank, 9 R. I. 308 (1869). '"Smith v. Law, 21 N. Y. 296 (1860); Western Imp. Co. v. Bank, 103 Iowa 455 (1897)- Met. Tel. Co. v. Domestic Tel. Co., 44 N. J. Eq. 568 (1888); McNeil v. Chamber of Commerce, 154 Mass. 277 (1891). 368 CORPORATE LAW [Bk. I- from time to time be reported to the board, either by direct re- port or by submission of the committee minutes. Unless otherwise expressly provided, the majority of any standing committee constitutes a quorum, and a majority of that quorum has power to act. 82 "Burleigh v. Ford, 61 N. H. 360 (1881); State v. Jersey City. 27 N. J. L. 493 (1859); McNeil v. Boston Chamber of Com., 154 Mass. 277 (1891). MINUTES OF MEETINGS 433. The Corporate Books The financial records of a corporation are much the same as those of a firm or individual. Some of their entries and accounts are peculiar to the corporation but the books do not'differ from those of any other form of business organization. 1 The more important books of record peculiar to the corpora- tion are the minute book, the stock certificate book, the transfer book, and the stock book and stock ledger, all of which are kept by the secretary of the corporation. . 434. The Minute Book The minute book of a corporation properly kept is legal evidence of the proceedings of its stockholders' and directors' meetings. The secretary is its custodian and its entries should be made by him alone. Any director has the right to inspect this book at any suitable time. A stockholder usually does not have this right. The minute book is ordinarily a blank book of the style termed "record" by stationers. It may be had at any price from plainly bound books at $i or less, up to elaborately bound and specially printed books costing from $5 to $25 or even more. A reasonably good and substantially bound book is always to be desired. The minute book varies in size and general form according to the taste or requirements of the secretary. A common and convenient form is 8^2 x 13 inches. Sometimes the book is 1 See I 445; also Book III, "Corporate Accounting." 369 370 CORPORATE LAW [Bk. I- specially made, of a size and style to match the other corporate records. For a small corporation with few meetings, a book containing 100 pages will usually be found amply sufficient. When the minutes are kept in a substantially bound volume with longhand entries succeeding each other in regular order, later additions or insertions are difficult if not impossible, and the evidence of the minutes as to proceedings at the company's meetings is difficult to controvert. Minutes are, however, not infrequently written with the typewriter on sheets of thin paper, which are then pasted in the minute book. Also at times loose-leaf minute books are em- ployed, in which the pages may be removed and, after the minutes are written upon them, be reinserted in the book. When either of these plans is followed, substitutions and alterations in the minutes may be made with comparative ease and their value as evidence is diminished. To avoid this objection to the convenient loose-leaf minute book, each page is sometimes water-marked with its proper number in such manner that substitution is extremely difficult and practically impossible. The same end is sometimes accom- plished by the inscription of the president's and secretary's signatures or initials on each page, making substitution without the participation of these officials impossible. It is obvious that this latter method of verification may also be effectively employed when minutes are pasted into the minute book. 435. Contents of Minute Book A copy of the company's charter or certificate of incorpora- tion is usually entered on the first pages of the minute book. This may be a copy certified by the secretary of state, bound or pasted into the book, or, equally sufficient, a careful and legible copy written in the book by the secretary, or, if written on separate sheets, bound or pasted into the minute book. If the copy is made by him, the secretary usually certifies to its cor- rectness. Ch. 45] MINUTES OF MEETINGS 371 Following the charter come the by-laws of the company. These begin at the top of the next right-hand page and should also be a careful and legible copy, or a copy bound or pasted in, followed by the secretary's certificate as to the accuracy of the transcription. A few pages immediately following the by-laws should be left blank for the entry of any amendments. Then follow the minutes of the first meeting of stockholders, closely followed by the proceedings of the first meeting of directors, and thereafter the minutes of stockholders' and directors' meetings in due se- quence as held, each with its distinctive heading. Each meeting should begin at the top of its proper page and no blank pages should be left between the records of the different meetings. In the larger corporations separate minute books are pro- vided for stockholders' and directors' minutes and also for the minutes of standing committees. In the smaller corporations a single minute book will usually suffice. 436. Form and Subject Matter of Minutes The secretary should spare no pains to secure accuracy in his minutes, since they are the legal evidence of the proceedings of the meetings recorded and the authority for any action of the officers required thereby. The minutes given in the latter part of this work are in con- ventional form. This has the advantage of brevity. Any clear statement of the proceedings is, however, legally sufficient, though a reasonably close adherence to the conventional arrange- ment is desirable. 2 It is usual to enter on the minutes of directors' meetings the names of those present. Save in the case of very small corpora- tions, it is not customary nor necessary to enter on the minutes the names of stockholders present at a stockholders' meeting. The secretary should, however, check off on his alphabetical ' See Book IV, Ch. XVI, "Minutes of Corporate Meetings." 372 CORPORATE LAW [Bk. I- list those in attendance and thus preserve a record of the stock- holders present at meetings. During the progress of meetings, letters, reports, and other instruments are frequently presented. When of importance, the secretary is usually instructed to enter these upon the minutes. If not instructed, he may use his discretion. If the matters to which they relate are important, they should usually be spread upon the minutes, i.e., entered in full. Generally, however, it is sufficient if the instruments be filed and preserved, such reference being made to them in the minutes as the conditions may demand. When reports or other instruments are ordered spread upon the minutes, the secretary may usually exercise his discretion as to whether they shall be included in the body of the minutes or follow immediately after them. If, however, the motion or order directs that the instrument follow the minutes, or that it appear in the body of the minutes, the secretary should comply with the letter of his instructions. 437. Recording the Proceedings The corporate minutes are a record of the transactions of corporate meetings a record of what is done, not of what is said; and the record should usually be as concise and accurate as possible. If a motion or resolution is passed upon at a meeting, no matter whether adopted or rejected, its disposition should be recorded, but, speaking generally, the debate and discussion should not be set down, nor are the names of the parties by whom minor motions or resolutions are made or seconded of sufficient importance to be entered, nor need any record be made of those voting for or against any such matter. It may be said further that when the presiding officer decides that a motion or a resolution is properly before the meeting and puts it to vote, the fact that the names of the parties who moved and seconded it or who voted for or against it are not recorded, Ch. 45] MINUTES OF MEETINGS 373 does not affect the force of the corporate action. If, however, a motion or a resolution is of importance, or is contested, or of such a nature that it may thereafter be of importance to know by whom the matter was introduced and by whom it was favored and opposed, the record should be made in full. It sometimes happens that a stockholder or a member oppos- ing some proposed action wishes his objections or protest recorded in the minutes. If his objections are pertinent and not too lengthy, this should usually be permitted, but the secretary should not enter any such objections upon his record unless so directed by a vote of the meeting or by unopposed direction of the presiding officer. The objecting member sometimes files his protest in writing and in such case the document should be received and filed in the usual course of business, and this fact be noted in the minutes. In some cases it is necessary for a member of the board to have the dissent to proposed action noted in order to avoid liability. In such case he has a right to demand its entry upon the minutes, and, if refused, may force its entry by proper legal procedure. Motions are not usually entered verbatim. It is sufficient if their sense is preserved. Resolutions are, however, more for- mal and should usually be entered in the exact form in which they are adopted. 3 The presiding officer of the meeting may always require resolutions and important motions to be reduced to writing before consideration, and if he does this the work of the secretary is greatly lightened. All papers presented to or used at meetings should be filed for future reference in the custody of the secretary, unless other- wise ordered. Notes of the proceedings are taken as the meeting progresses, and these should be written up in permanent form as soon after the meeting as possible while the events are fresh in the secre- tary's mind. Should he delay the final entry of his record unduly, doubt may arise as to whether the secretary's notes, or the See Book IV, Ch. XIV. "Motions and Resolutions." 374 CORPORATE LAW [Bk. I- record of the minute book is the original entry, and if it should be held that the formal minutes are not the original entry, their value as evidence is destroyed. If minutes are used as evidence, the secretary will be asked when he wrote up his final record. As soon as the minutes are duly entered in the minute book, they should be signed with the official signatures of the secretary and the presiding officer of the meeting, the secretary usually signing at the right and the presiding officer at the left. 438. Approval and Amendment of Minutes Minutes should be approved by the body whose proceedings they record. The approval of stockholders' minutes by the board of directors is absolutely ineffective, as is also the approval of directors' minutes by the stockholders, save by way of indorse- ment or ratification of the directors' action recorded therein. The minutes of a stockholders' annual or special meeting cannot be approved at a subsequent special meeting unless such approval is noted in the call and notice ; but the minutes of any preceding stockholders' meetings, whether annual or special, may always be approved at the stockholders' annual meeting. Likewise the approval of the minutes of a directors' regular or special meeting at a subsequent special meeting is effective if such approval was duly notified as one of the purposes of the meeting; while any unapproved minutes of directors' meetings may always be approved at a regular meeting of directors. The minutes of a stockholders' meeting are usually not passed upon until the following annual meeting, when all unapproved minutes should be read and, if no objections are offered, ap- proved. Directors' minutes likewise are usually approved only at regular meetings. The approval of minutes relieves the secre- tary of all direct responsibility for the accuracy of their record and also serves as a ratification of the proceedings recorded therein. 4 When minutes are approved, no record need be made save the statement in the minutes of the meeting then in progress 4 Delano v. Trustees, 138 Mass. 63 (1884); County Court v. Ry. Co. 35 Fed. Rep. 161 (1888). Ch. 45] MINUTES OF MEETINGS 375 that the minutes of the previous meeting or meetings, giving their dates, were read and approved. Usually, however, for convenience the secretary also notes at the bottom of each set of approved minutes the proper facts, as "Approved at the annual meeting of stockholders held January 10, 1917." If corrections of minutes are ordered, the minutes of the meeting then in session should show exactly what corrections were directed and in what minutes. In the corrected minutes the alteration should appear in red and a marginal note should give the date of the meeting at which such correction was directed. Red lines may be drawn through any part ordered stricken out and any correction be interlined, but no erasure should be made in any case, as the corrected minutes should show both the error and the correction. Sometimes it happens that those present at a meeting decide, contrary to the facts, that the secretary has made errors in his record of a preceding meeting, and move that a portion of the minutes be stricken out or corrected. Whether right or wrong, if the majority of those present at the meeting vote in favor of the motion, the secretary must carry it into effect. In such case he should draw red lines through the part ordered stricken out and interline in red any matter ordered inserted, and make the proper entry in the margin of the minutes. This then shows the whole matter that the record was made in one way, and was at a later date ordered changed. The minutes of the meeting at which such change was ordered should also give a complete statement of the matter. 439. "Cut and Dried" Minutes The annual meeting of stockholders is frequently held in a locality distant from the residence of the parties really in interest, as for instance the meetings of the non-resident corporations of New Jersey, Maine, and many other states, which must be held within the state of incorporation. Also there are many cor- porations in which the whole or the greater part of the stock is 376 CORPORATE LAW [Bk. I- held by combinations and the subordinate corporations hold only such meetings as are essential to maintain their legal existence. In these and in many other cases the only necessity for meetings is to give the proper legal expression to matters that are already determined, and it is possible to write out the entire minutes in advance. The proceedings at such meetings are simple. A controlling interest, usually in the shape of proxies, is sent or taken to the place of meeting. If the regular officers are not present or are not authorized to act, officials for the meeting are appointed at the time by those holding these proxies. The prepared minutes are then read and agreed to, the meeting is adjourned, and the accepted minutes, signed by the officials who acted at the meet- ing, are returned to the secretary of the company and preserved in his minute book. 5 ' For detailed account of such a meeting, see Book II, 5 30. Part X The Treasurer CHAPTER XLVI TREASURER'S DUTIES AND POWERS 440. General The duties, powers, and liabilities of the treasurer as one of the officers and directors of the corporation will be found in earlier chapters dealing generally with the duties and liabilities of the officers and directors. The present chapter and those following deal with those duties and liabilities which belong more particularly to the office of treasurer alone. 441. The Treasurer's Primary Duty The treasurer is the official custodian of the corporate funds,* and his primary duty is to receive them, care for them, and disburse them. Other duties assigned to him are usually in some way connected with or related to this primary duty. 442. The Treasurer's Authority The by-laws are almost invariably the source from which come both the powers and the duties of the treasurer. Statutes rarely specify his duties. In New Jersey, Pennsylvania, and a few other states the treasurer is required by statute to give a bond, and in Pennsylvania the treasurer must keep the moneys of the corporation in a separate book account to his credit as treasurer; but, broadly speaking, the whole matter of the treas- urer's duties is left to the discretion of the corporation. In New 1 Laurel Springs Land Co. v. Fougeray. 57 N. J. Eq. 318 (1898). 377 378 CORPORATE LAW [Bk.I- York, New Jersey, and some other states where the statutes permit special charter provisions, the treasurer's duties may be specified therein, but such regulations properly belong in the by-laws and are almost invariably found there. In the care and management of the corporate funds and for the discharge of any duties connected therewith, the treasurer is the active agent of the corporation, and of its governing body, the board of lirectors. He is therefore subject to the direction of this board in all such matters, except in so far as his powers and duties have already been prescribed by higher authority. If no provision as to the powers and duties of the treasurer are found in the charter or by-laws of the corporation, the directors, as an incident of their general control of the corporate affairs, are fully competent to determine these powers and duties and to authorize him to do whatever is required. The treasurer is expected to inform himself as to the powers and duties pertaining to his office and must look for his authority, first, in the charter and by-laws, and second, in the resolutions of the board of directors. f.^bnni otjiiocrtin -oJ^j.n !i;nillo on ; 443. By-Law Provisions^ By-law provisions relating to the treasurer differ in each corporation, but the following by-law extract presents an excel- lent synopsis of the usual duties of the treasurer: Y*in r 01 IT Section 5. 'The Treasurer The Treasurer shall have the custody of and be responsible for all moneys and securities of the Company; shall keep full and accurate records and accounts in books belonging to the Company, showing the transactions of the Company, its accounts, liabilities, and financial condition, and shall see that all expenditures are duly authorized and are evidenced by proper receipts and vouchers. He shall deposit, in the name of the Company, in such depositary or depositaries as are approved by the Directors, all moneys that may come into his hands for the Company account. His books and accounts shall be open at all times during business hours to the inspection of any Director of the Company. Ch. 46] TREASURER'S DUTIES AND POWERS 379 The Treasurer shall also indorse for collection or deposit all bills, notes, checks, and other negotiable instruments of the Company; shall pay out money as may be necessary in the transactions of the Company, either by special or general direction of the Board of Directors, and on checks signed by the President and himself, and shaU generally, together with the President, have supervision of the finances of the Company. He shall also make a full report of the financial condition of the Company for the annual meeting of the stockholders, and shall make such other reports and statements as may be required of him by the Board of Directors or by the laws of the State. 2 He shall give bond in the sum of Five Thousand Dollars, with sureties satisfactory to the Board of Directors, for the faithful performance of his duties and for the restoration to the Company, in event of his death, resignation, or removal from office, of all books, papers, vouchers, money, and other property belonging to the Company that may have come into his custody. He shall receive such compensation, not exceeding Five Thousand Dollars per annum, as may be fixed by the Board of Directors. By these provisions the treasurer is given entire custody and charge of the corporate moneys and securities, though not of the general property belonging to the company. These pro- visions could be extended to cover other property, if desired. In the by-laws of the larger corporations it is usually though not invariably the case that the powers and duties of the treas- urer are specified in much detail. The following provision, de- fining the powers and duties of the treasurer, is taken from the by-laws of the United States Steel Corporation: Section 7. Powers and Duties of Treasurer. The treasurer shall have custody of all the funds and securities of the Company which may have come into his hands; when necessary or proper he shall indorse on behalf of the Company, for collection, checks, notes, and other obligations, and shall deposit the same to the credit of the Company in such bank or banks or depositary as the Board of Directors or the Finance Committee may designate; he shall sign all receipts and vouchers for payments made to the Company; jointly with such other officer as may be designated by 1 For a form of treasurer's report, see Book IV, Forms 264, 265. 380 CORPORATE LAW > [Bk. I- the Finance Committee, he shall sign all checks made by the Company, and shall pay out and dispose of the same under the direction of the Board or of the Finance Committee ; he shall sign with the president, or such other person or persons as may be designated for the purpose by the Board of Directors or the Finance Committee, all bills of exchange and promissory notes of the Com- pany; he may sign, with the president or a vice-president, all certificates of shares in the capital stock; whenever required by the Board of Directors or by the Finance Committee, he shall render a statement of his cash account ; he shall enter regularly, in books of the Company, to be kept by him for the purpose, full and accurate account of all moneys received and paid by him on ac- count of the Company; he shall, at all reasonable times, exhibit his books and accounts to any director of the Company upon applica- tion at the office of the Company during business hours; and he shall perform all acts incident to the position of treasurer, subject to the control of the Board of Directors or of the Finance Committee. He shall give a bond for the faithful discharge of his duties in such sum as the Board of Directors or the Finance Committee may require. As will be noted, the treasurer is subordinated to the board of directors and to the finance committee. In the present in- stance he is still further held in check by another by-law pro- vision subjecting him to removal without cause at the pleasure of the directors. Under such circumstances, it is not probable that the treasurer will lightly oppose the wishes or instructions of the directors. In the same by-laws, provision is made for assistant treasurers as follows: Section 8. Assistant Treasurers. The Board of Directors or the Finance Committee may appoint an assistant treasurer or more than one assistant treasurer. Each assistant treasurer shall have such pov/ers and shall perform such duties as may be assigned to him by the Board of Directors, or by the Finance Committee. The by-law provisions relating to the treasurer are simpler in the smaller corporations. The following are usual provisions: Ch. 46] TREASURER'S DUTIES AND POWERS 381 The Treasurer shall have the custody of all moneys and securi- ties of the Company, and shall keep regular books of account and balance the same each month. He shall sign or countersign such instruments as require his signature, and shall perform all other duties incident to his office or that are properly required of him by the Board of Directors. The Moneys of the Company shall be deposited in the name of the Company in such bank or trust company as the Board of Directors shall designate, and shall be drawn only by check signed by the Treasurer and countersigned by the President of the Company. 444. Directors' Resolutions The directors ordinarily cannot change the provisions of the by-laws as to the powers and duties of the treasurer; but they are generally required, as in the examples of by-laws given in the preceding section, to supplement them by designating the de- positary of the corporate funds, and by prescribing any other working details which may be necessary and do not conflict with the by-law provisions. In a few states the directors either have power under the statute to make and alter the by-laws, or may be given such power in the certificate of incorporation itself. When this is the case the directors are enabled thereby to exercise complete and unquestioned control over the corporate officials. 445. Books of Account The treasurer has, as a matter of course, charge of the cor- porate books of account. 3 In the smaller corporations he is usually either acting bookkeeper or has direct control of the books of account and keeps his own special books as well. A knowledge of bookkeeping and of the financial duties connected with his office is then a necessary qualification. In the larger corporations the treasurer's duties do not usually include the details of accounting. These devolve upon subordinate em- 1 See Book III, Ch. I, "The Corporate Records and Accounts.' 382 CORPORATE LAW [Bk. I- ployees, or are perhaps relegated to an accounting department, leaving the treasurer free to devote his attention to the general overseeing and management of the corporate finances and finan- cial affairs. In many of the larger corporations the actua* duties of the treasurer are nominal, the usual duties of that official being assigned to other officers or employees of the corporation. The treasurer is then, as a rule, selected because of his financial responsibility or connections, or for other reasons that make his election desirable. 440. Assumption of Official Duties The procedure and formalities when the newly elected treas- urer assumes the duties of his office are simple. Usually he is required to give bond, and this must be done in accordance with the requirements of the particular corporation before he may enter upon the duties of his office. As soon, however, as he has qualified for his position by giving a satisfactory bond and complying with any other requirements of the corporation, he is ready and entitled to take possession of his office and begin the discharge of his official duties. The retiring treasurer, on the other hand, retains his position as treasurer of the corporation and has authority to perform all its usual duties until the treasurer-elect has qualified and assumed the duties of his office. Then, however, the authority of the retiring treasurer immediately terminates, he is no longer competent to exercise any of the functions of the office, and, unless otherwise instructed by the board, must at once turn over to the new official all corporate property in his custody, including the books of account. The retiring treasurer, in preparation for the surrender of his office, usually closes his books and prepares a balance sheat, giving a more or less complete statement of the general financial condition of the corporation. Also an audit of his accounts is desirable, particularly when the corporate assets are material, Ch. 46] TREASURER'S DUTIES AND POWERS 383 The audit of the retiring treasurer's books relieves the in- coming treasurer from any responsibility as to their condition. He takes them as they are, but must assure himself that the corporate funds and other property turned over to him by the retiring treasurer accord with the books. If he does not, his negligence in the matter may render him liable for any resulting loss to the corporation. The incoming treasurer should at once notify the deposi- taries in which the corporate funds are held, of his election and assumption of office. If the corporate funds have been deposited in the name of the treasurer of the corporation, it will be neces- sary for them to be transferred to the treasurer-elect by check of the retiring official. If, however, the funds are deposited in the corporate name, no such transfer is necessary. There is then no change in their ownership but merely a change in the officer by whom checks are drawn, and proper certification to the bank of this change is all that is required. 4 Should the out- going treasurer refuse to turn over to the treasurer-elect any property which belongs to the corporation, the directors, or even the treasurer himself, may bring suit for its recovery. As a matter of course, the treasurer should give his predecessor a receipt for the corporate property turned over. 447. Formalities on Giving Up Office When the treasurer relinquishes, or is ousted from, his posi- tion, all properties of the company in his possession, including the books of account, should be surrendered to his successor or to such other party as may be designated by the board of direc- tors. The incoming treasurer is the usual and proper party to whom such property is delivered. The retiring treasurer should be given receipts for all properties turned over. The corporate accounts are always the property of the cor- poration. Sometimes in the smaller corporations the books in which these accounts are kept have been purchased by the Se Book IV. Form 227. 384 CORPORATE LAW [Bk. I- treasurer personally and the question as to their ownership then arises. As a matter of law, the treasurer must surrender the books in which the accounts are kept although these books have been purchased with his personal funds. He is entitled hi such case to payment for the books, but he cannot withhold them as a means of enforcing this payment or on the plea that they are his. 5 In order to prevent any complications on this score, it is sometimes provided in the by-laws that the accounts of the company shall be kept only in books that are the property of the corporation. ' State v. Goll, 32 N. J. L. 285 (1867); High on Extraordinary Legal Remedies, | 306. CHAPTER XLVII TREASURER'S RELATION TO OTHER CORPORATE AUTHORITIES 448. To the Stockholders The treasurer is the agent of the corporation but under the usual corporate arrangements his direct responsibility is to the board of directors, not to the stockholders. In practice the treasurer usually has no official connection with the stockholders, save perhaps when an annual or an occasional special report is to be made, when dividends are to be paid, or amounts due from the stockholders to the corporation are to be collected. He is not under their supervision and owes them no direct duty. He must obey their instructions as expressed in the by-laws of the corporation, but this is the limit of their usual authority. Should they attempt to compel his action by direct motion or resolution, they exceed their power and the treasurer is under no legal obligation to obey. As stated in an early case, "The individual members of the corporation, whether they should all join, orpach act separately have no right or power to intermeddle with the property or con- cerns of the bank, or call any officer, agent or servant to account, or discharge them from any liability." 1 449. To the Board of Directors Speaking generally, the treasurer is directly responsible to the directors and must obey their instructions. Occasionally, how- ever, the charter gives him certain specified powers and almost invariably the by-laws define his authority and prescribe his 1 Smith v. Kurd, 12 Mete. (Mass.) 371, 385 (1847). 385 386 CORPORATE LAW [Bk. I- duties in detail. It is then beyond the power of the directors to disturb him in the exercise of the authority and the performance of the duties prescribed by these higher corporate authorities. For instance, the charter may provide that the treasurer shall be, ex officio, a member of the finance committee. If so, the directors cannot deny him this right so long as the charter pro- vision remains unchanged. Or the by-laws may, as is usual, assign the custody of the corporate funds to the treasurer. Should the directors, in defiance of this by-law provision, instruct the treasurer to surrender the corporate funds to the custody of some other officer of the company, they would, save perhaps in case of some special emergency, exceed their authority and the treasurer need not obey their instructions. On the contrary, should he obey them and should loss result to the company as a consequence, the treasurer himself might be held responsible. The treasurer must, however, obey all such proper instruc- tions of the directors as are not in conflict with charter or by-law provisions, or are intended to supplement and make them effec- tive. In all such matters the directors are entirely within the scope of their powers and their instructions are as binding upon the treasurer as are the by-laws themselves. Sometimes also the directors are given express authority to modify, repeal, or amend the by-laws, and their power over the official acts of the treasurer is then practically complete. When this is the case, statutory and charter provisions alone are su- perior to their authority. It may be added, however, that the powers discussed are the powers of the board of directors and not of the individual directors composing the board. These individual directors have certain powers of their own. Thus, without special authoriza- tion thereto, any member of the board of directors may inspect the corporate books at any reasonable time save for purposes hostile to the corporation 2 and may examine at his discretion into the acts of the treasurer or of any other corporate official, 2 Heminway v. Heminway, 58 Conn. 443 (1890); People v. Central Fish Co., 117 App. Div. (N. Y.) 77 (1907). Ch. 47] TREASURER'S RELATION TO OTHERS 387 though he cannot delegate this official right to an audit company. 3 Also as an individual director, he may make such suggestions to the corporate officials as he sees fit and such suggestions will naturally have weight. The individual director has not, however, any power to en- force compliance with his suggestions, nor has he the right to change, censure, suspend, remove, or even direct an officer of the corporation, such rights and powers inhering only in the board collectively. A director may be specially authorized by the board to do any of these things and will then have all necessary power for its performance, but he has no such authority by mere virtue of his board membership. The treasurer reports to the directors and, as already stated, is governed by their instructions in all matters not specifically covered by charter or by-law provisions. The relations between the treasurer and the board of directors are therefore very close and are usually harmonious. Both are supposed to have the financial welfare of the corporation at heart and to be working together to advance it, and it is but rarely that the exact measure of the board's authority over the treasurer, or of the treasurer's independence of the board, comes into question. 450. To the Finance Committee Nominally the finance committee is subject to the board of directors. It is, however, always composed of members of the board and generally of its best financiers, and the directors are usually and wisely quite content to leave the financial manage- ment of the corporation entirely in its hands. The finance com- mittee is then practically the board of directors so far as the finances of the corporation are concerned. The committee will naturally report to the directors at frequent intervals, but its reports, acts, and recommendations are usually sure of approval in advance. In practice, a finance committee possessing the People v. Borgstede. 169 App. Div. (N.'Y.) 421 (1915); People v. Throop, 12 Wend. (N. Y.) 183 (1834). 388 CORPORATE LAW (Bk. I- confidence of the board will direct the financial affairs of the corporation from year's end to year's end without interference. The allegiance, co-operation, and obedience the treasurer ordinarily owes to the directors is then transferred to this com- mittee. If the treasurer is a member of the board of directors, he is usually also a member, ex officio, of the finance committee and participates in its proceedings. If, however, he is not a director, he cannot be made an active member of the committee. This is, as already stated, because the committee exercises discretionary powers belonging to the board, which cannot be legally conferred upon a committee composed in whole or in part of members who are not directors. If the treasurer is a member of the finance committee, and particularly if he is of some financial ability and standing himself, the direct and entire charge of the financial affairs of the corpora- tion is apt to be left in his hands, the remainder of the committee acting merely in an advisory capacity. Even where the treasurer is not a member of the committee, the financial matters of the corporation are still as a rule left largely to his care. In such case he reports frequently and informally to the committee, either receiving authority for the particular act or policy under discussion, or approval of his actions in matters which have already been consummated. When the treasurer has not sufficient experience and ability to conduct the general financial affairs of the company to this extent, he works in close accord with the members of the finance committee, carrying out their instructions, consulting with them frequently, and at all times referring to them matters of impor- tance, or such as may be beyond his immediate authority, ability, or control. Since the finance committee practically takes the place of the board of directors so far as the corporate finances are con- cerned, it usually and naturally has all the authority of the board itself over the treasurer. The matter is, however, one that may Ch. 47] TREASURER'S RELATION TO OTHERS be determined absolutely by the charter or by-laws. These usually and properly prescribe that the treasurer shall report to, and be controlled by, the finance committee. The following by-law provisions define with much clearness the usual scope and powers of the finance committee and its authority over the treasurer. They are found under the head of "Standing Committees" in the by-laws quoted from in the pre- ceding chapter: The Finance Committee shall have general and special charge and control of all financial affairs of the Company, and shall have and exercise all of the powers of the Board of Directors in such financial matters when the latter is not in session. The Treasurer and the Auditor of the Company shall be under the direct control and supervision of the Finance Committee. The Finance Committee shall fix all salaries and compensation paid or payable to officials of the Company, except as otherwise provided in these by-laws or fixed by resolution of the Board of Directors. It will be noted that the financial affairs of the company are placed unreservedly in the hands of the committee in the interim between board meetings; also that the treasurer is expressly subordinated to its authority. The general relation between the finance committee and the treasurer should be that of harmonious and effective co-operation. Both are working to the same end, i.e., the best possible admin- istration of the financial affairs of the corporation, and there should be no conflict or friction between them. 451. To the Auditor In the smaller corporations the auditor is merely an occasional officer called in for the purpose of investigating and passing upon the treasurer's accounts. In such case his relation to the treasurer is temporary and needs no special discussion. The treasurer's books are opened to the auditor, who examines them, checks up their statements, and reports his finding to the board. 390 CORPORATE LAW [Bk. I- The treasurer will, naturally, furnish any proper information and assistance required by the auditor in the course of this exam- ination and will facilitate his work in every way. In the larger corporations, however, the conditions are ma- terially different. Here the auditor, or comptroller as he is sometimes designated, is one of the regular officials of the cor- poration, and his duties and the relations existing between him and the treasurer depend entirely upon the respective duties of the two officials. These are usually set forth in the by-laws and vary in different corporations. < In the larger corporations the auditor is the accounting officer, taking entire charge of the general bookkeeping. The actual receipt, custody, and disbursement of the funds and their general management remain with the treasurer. Detailed records of these receipts and disbursements as well as the general accounts of the corporation are kept in the auditor's department, the treasurer's records also covering these items but in a less detailed way. In some corporations, accounts to be paid are authorized by the auditor, are approved perhaps by some other officer, and the actual payment is made by the treasurer. In other cases the payments are for all practical purposes made by the auditor; vouchers, duly signed and countersigned, being sent out to the parties to whom payments are due, and these vouchers being payable on presentation to some designated bank which acts for the treasurer. Or again, the voucher will be prepared or passed upon by the auditor and perhaps by the official in whose depart- ment the obligation arises, and this voucher when signed by the treasurer becomes a check, honored upon presentation at a designated bank. The whole matter is one of adjustment, varying, as stated, in different corporations. In any case the auditor and the treasurer usually have distinct departments, and while their accounts overlap in some measure as to cash received and dis- 4 See | 308. Ch. 47] TREASURER'S RELATION TO OTHERS 391 bursed, there is but little room for conflict between them. Each is independent of the other and exercises functions that should be distinct and so clearly denned that clashing is impossible. 452. To the Other Officials The three essential executive officers of the corporation are the president, the secretary, and the treasurer. In the usual corporate organization the president is the superior officer of the three, and is usually given certain powers of supervision over the other two. The secretary and treasurer are entirely independent of each other. Also their respective functions are so distinct that friction between them is unusual and absolutely unnecessary. In the smaller corporations the two offices are frequently and advantageously united in the same person. Between the president and the treasurer the probability of friction is much greater. The president, as already stated, is usually given certain general powers of supervision over the other corporate officers, and, as these powers are rarely denned with clearness, there is at times room for real difference of opinion as to their limits. Under the usual by-law provisions the president has the right to inspect and examine the books, accounts, and records of the treasurer at any reasonable time. 5 He has, however, no right to interfere directly with the. treasurer's actions unless he sees some actual neglect or improper performance of duty. In any such case it is his duty to call the matter to the treasurer's attention. If the latter is obviously at fault, it is his duty to heed the president's instructions. If, however, there is a differ- ence of opinion between the two officials as to whether or not the treasurer is at fault, the president, unless specially empowered, cannot enforce his views directly. All he can do is to report the matter to the directors, and both officers will then be governed by the directors' decision. People, etc. v. Goldstein. 37 App. Div. (N. Y.) sso (i8go). 392 CORPORATE LAW [Bk. I- As the president is the chief executive officer of the corpora- tion, the treasurer is naturally expected to confer with him on matters of unusual importance or difficulty and to be guided to a greater or less extent by his opinions and suggestions. The president, however, as stated, cannot himself force the treasurer to heed his instructions unless he has been given some special power in the matter by charter or by-law provisions, or by action of the board of directors. The offices of president and treasurer are occasionally united in one person but not commonly, as the respective duties of the two positions are apt to conflict. Thus in some states the statutes require the signature of both the president and treasurer to certificates of stock, and the by-laws commonly prescribe a similar signature for the corporate checks and other instruments. It is obvious that the whole purpose of these precautionary measures would be defeated if the two offices were combined. CHAPTER XLVIII THE TREASURER'S LIABILITIES 453. The Treasurer as Agent The treasurer's duty in regard to the moneys and the prop- erty of the corporation entrusted to his care is that of an agent, and he is held to the same measure of accountability. In an early New York case it was expressed as follows: "The duty of a treasurer is to keep the moneys of his principal distinct from his own, and to be ready at all times to pay over what balance he owes to his principal." With sage recognition of the fact that readiness to perform is not performance, the learned judge continues, "and to pay the balance on demand." 1 In his duties outside tho e relating directly to the custody of the corporate funds and property, the treasurer is likewise acting as an agent and employee of the corporation, and is liable to it if he fails in the proper performance of these duties, as is any other agent or employee. 454. To Whom Liable When liability is incurred by the treasurer in connection with the duties of his office, it is usually to the corporation though it may be to the individual stockholders of the corpora- tion, or even to individuals outside the corporation. Beyond this there is in some states a civil liability for the non-perform- ance of certain duties prescribed by statute, and in all states there is a criminal liability for acts in violation of the penal statutes. Thus, if the treasurer loses a portion of the company funds ' Second Ave. R. R. Co. v. Coleman, 24 Barb. (N. Y.) 300 (1857); Hunter v. Robbins, 117 Fed. Rep. 920 (1902). 393 394 CORPORATE LAW [Bk. I- through careless handling, he is responsible to the corporation. If he makes an official report to the stockholders which is false in some material respect and the stockholders act upon this false information and lose money thereby, the treasurer is per- sonally liable to the individual stockholders by whom these losses are incurred. Or if he misrepresents the financial status and ability of the corporation to an outsider in order to induce him to give credit to the company, he is liable to such outsider for any losses incurred as a result of his false representations. In many states if he fails to make certain specified reports, he is liable to fine. In all states, if he embezzles the corporate funds or uses his official position to defraud, he is subject to a criminal prosecution. 455. Sources of Liability Speaking generally, the treasurer may be liable for failure to perform, or for the improper performance of the duties of his office, as follows: 1. Neglect of or non-performance of duties. 2. Faulty performance of duties. 3. Unauthorized acts. 4. Illegal acts. 456. (i) Neglect or Non-Performance of Duties As a rule the treasurer is liable for any loss or damage in- curred through his neglect of or failure to perform his duties. Thus, if he fails to deposit the corporate funds in due time, or in accordance with the requirements of the by-laws or the directors, and because of this neglect they are burned, stolen, or otherwise lost, the treasurer is responsible to the corporation. Or if money is due and the treasurer does not take the necessary steps for its collection, and as a result it is lost to the corporation, he is again responsible. Or if he refuses to perform his proper duties and the corporation is involved in losses thereby, he is responsible to the corporation for the amount so lost. Ch. 48] TREASURER'S LIABILITIES 395 In any case of loss to the corporation because of neglect of duty on the part of the treasurer, the measure of his liability is usually the amount actually lost, or the damage actually sus- tained in consequence of such failure or non-performance. He cannot ordinarily be held liable for losses indirectly due to his failure. It is to be noted that the liability of the treasurer for neglect or non-performance of his duty is to the corporation, and not to the individual stockholders. Any action, therefore, against the treasurer for losses incurred by reason of his neglect or failure must be instituted by the board of directors, and not by the stockholders, either as a body or individually. In the larger corporations and wherever the value of the corporate funds and property in the treasurer's hands is mate- rial, it is usual to require him to give bond for the faithful per- formance of his duties. This bond, if good and of sufficient amount, will usually cover any losses occasioned by the failure or the misdeeds of the treasurer and be an efficient protection to the corporation. 2 457. (2) Faulty Performance of Duties The treasurer may render himself liable for faulty perform- ance of his duties as well as by neglect of these duties, and in such case his liability may be to outside parties or to the cor- poration. For instance, if the treasurer signs a note of the corporation, and, instead of using the proper corporate signa- ture, signs his own name followed by the term "Treasurer," he will in some states and under some circumstances make himself liable as a principal, although he had no intention of so doing and was not expected to be personally involved. 3 So also, if the treasurer in paying some corporate indebted- ness, carelessly draws a check for a larger amount than is re- 1 See Ch. XLIX, "The Treasurer's Bond." 1 Merchants Nat. Bank v. Clark el at.. 139 N. Y. 314 (1893); First Nat. Bk. v. Wallis, 150 N. Y. 455 (1896). 396 CORPORATE LAW [Bk. I- quired, and the excess cannot be recovered from the payee, the treasurer is liable to the corporation for its amount. The liability of the treasurer from faulty performance of duty seldom arises. His position is one of trust and responsi- bility, and the incumbent is usually experienced in business matters and accustomed to the handling of funds. Under these circumstances it is hardly to be expected that he will err so grossly in any of his official acts as to subject himself to liability. 458. (3) Unauthorized Acts The treasurer is the agent of the corporation, and within the scope of his authority can act for and bind it. If, however, he acts beyond the scope of his usual duties, not being authorized thereto, his act is without validity and the corporation is not necessarily bound. 4 Also, in any case of loss resulting from his unauthorized acts he is liable in damages to the party suffering such loss, whether it be the corporation or an individual. This is the usual liability of an agent exceeding his authority. 5 For instance, if the treasurer of a corporation, not being authorized thereto, orders a costly piece of machinery for the use of his company, the corporation may lawfully refuse to receive it even though the order was accepted by the manu- facturer on the supposition that the treasurer had been duly empowered to make the purchase. In such case the maker of the machinery is the injured party and may hold the treasurer personally responsible for any real loss involved in the trans- action. Or should the treasurer, not being authorized thereto, enter into a contract on behalf of the corporation to supply certain goods at a low price, the corporation is not bound by his agree- ment unless it ratifies his act, and, if it does not, the treasurer i;.> liable to the other party for any direct loss. 4 Daniele v. Burlington, etc., Co., 84 N. J. Eq. 53 (1914); Jacobus v. Jamestown Mantel Co., 211 N. Y. 154 (1914). 6 Kroeger v. Pitcairn, 101 Pa. St. 311 (1882); Baltzen et al. v. Nicholay, 53 N. Y. 407 (1873); Taylor v. Nostrand, 134 N. Y. 108 (1892). Ch. 48] TREASURER'S LIABILITIES 397 If, however, the treasurer, though really unauthorized there- to, performs some act within the apparent scope of his powers that is, an act within the powers usually incident to his office 6 or powers which he has been represented to the public as pos- sessing, 7 and the party with whom he deals is unaware of the treasurer's lack of authority, the corporation is bound by the act. If any loss results, the treasurer is liable to the corporation. For instance, if the treasurer, having neither express nor implied authority therefor, or perhaps acting contrary to the instruc- tions of the board, enters into a contract with a banking house' to discount a large amount of the corporation paper at such an unfavorable time or under such conditions as to involve a loss, and the banking house supposed the treasurer to have authority to make such contract, the corporation cannot repudiate the treasurer's action as unauthorized. 8 On the contrary, it must abide by the terms of the agreement and its only recourse is against the treasurer and the measure of its damages is the loss actually involved. The treasurer's general liability for unauthorized actions is well expressed in the following quotations: It is the first duty of an agent, whose authority is limited, to adhere faithfully to his instructions, in all cases to which they can be properly applied. If he exceeds or violates or neglects them, he is responsible for all losses which are the natural consequences of his act. 9 The cases in which agents have been adjudged liable personally have sometimes been classified as follows, viz.: first, where the agent makes a false representation of his authority with intent to deceive; second, where with knowledge of his want of authority but without intending any fraud, he assumes to act as though he were fully authorized; and third, where he undertakes to act, bona fide believing he has authority, but in fact has none, as in the case of an agent acting under a forged power of attorney. As to cases Traitel Marble Co. v. Brown Bros., 159 App. Div. (N. Y.) 485, 487 (1913). ' Culver v. Pocono, etc.. Ice Co., 206 Pa. St. 481 (1903). 8 Austrian & Co. v. Springer, 94 Mich. 343 (1892); Brown v. Franklin Mut. Fire Ins. Co., 164 Mass. 565 (1896). Whitney v. Merchants' Express Co., 104 Mass. 152, 154 (1870); also Wilts v. Morrell, 66 Barb. (N. Y.) 511 (1873); Taylor v. Nostrand, 134 N. Y. 108 (1892). 398 CORPORATE LAW [Bk. I- fairly brought within either of the first two classes there cannot be any doubt as to the personal liability of the self-constituted agent, and his liability may be enforced either by an action on the case for deceit, or by electing to treat him as principal. While the liability of agents in cases belonging to the third class, has sometimes been doubted, the weight of authority appears to be that they are also liable. 10 The treasurer may be liable for wrongfully paid dividends. 11 459. (4) Illegal Acts The illegal acts of which the treasurer is most commonly guilty may be divided into two classes: (i) fraudulent acts, such as false or misleading statements or reports as to the property or financial condition of the corporation made or cer- tified to by him; (2) criminal acts, such as embezzlement of the funds entrusted to his charge. Offenses of the first class are not infrequent and may be offenses against individuals, or against the state. In case of misrepresentation to individuals, the treasurer is liable to the parties misled as is any agent, 12 and may subject himself to a criminal liability as well. In case of false representations to the state, he is subject to special penalties provided by the statutes. False or fraudulent reports are prohibited by the laws of almost every state. Varying punishments are imposed. Usually the statutes provide that a treasurer making or concurring in any representation materially false in any of its details, shall be liable to any individual damaged thereby, to the amount of his loss. Frequently a further and more serious penalty is imposed, consisting of both fine and imprisonment. The criminal acts of the treasurer may be of two classes: (i) those inuring to his direct personal benefit, such as embezzle- 10 Kroeger v. Pitcairn, 101 Pa. St. 311, 317 (1882). 11 See 499. 12 Morgan v. Skiddy. 62 N. Y. 319, 326 (1875); Kroeger v. Pitcairn, 101 Pa. St. 311. 317 (1883). Ch. 48] TREASURER'S LIABILITIES 399 ment of the corporate funds or obtaining money under false pretenses from the corporation, or from those with whom the corporation is transacting business; (2) participation in acts of the corporation that would in an individual be criminal. The liability of the treasurer for criminal acts inuring to his personal benefit is the same as for any other individual. Such offenses are neither better nor worse, nor does their pun- ishment differ when committed by a corporation official. If criminal acts are committed by the corporation, the treas- urer or any other officer responsible therefor, or knowingly assisting or concurring therein, is liable to prosecution and punishment. 13 In such case it must be shown, however, that "the corporation did them by his hand, act, direction or per- mission, which of course is direct proof of his own acts, or such circumstances must be shown as to justify the conclusion, as a fact, that what the corporation did, he did." 14 In other words, he is an agent with an agent's usual liability, but no more. Thus, if the corporation obtains credit or moneys by means of false representations, i.e., under false pretenses, in order to hold the treasurer responsible, either civilly or criminally, it must be shown that he participated in such act or knowingly allowed it to be done. 15 As a corporation cannot be held crimi- nally liable, and as it is far more difficult to secure the criminal conviction of its officials than to enforce a civil liability, criminal prosecutions against the treasurer in cases of the kind are exceedingly rare. Civil prosecutions are not so uncommon and if his participation and responsibility can be proved, he is held. Outside of false representations, acts involving criminal lia- bility are not often committed under corporate direction. Some- times, however, they do occur, as where the agents of a cor- poration resort to violence or the destruction of property of a rival concern in order to hinder or prevent its success. In any a Weber v. Weber. 47 Mich. 569 (1882); Hubbard v. Weare, 79 Iowa 678 (1890); Vreeland v. N. J. Stone Co.. 29 N. j. Eg. 188 (1878). "People v. England, 27 Hun (N. Y.) 139 (1882). "Wakeman v. Dalley, 51 N. Y. 27 (1872); Arthur v. Griswold, 55 N. Y. 400 (1874); Morgan v. Skiady, 62 N. Y. 319 (1875). 400 CORPORATE LAW [Bk. I- such case the corporation itself can naturally be held only in damages, but the agents, by whom the criminal act is performed, are liable to punishment as if the act were their own deed, insti- gated and committed by them alone. 460. Statutory Liabilities In many of the states the liabilities discussed in the present chapter, which in the main are common law liabilities, have been further enacted into statutory liabilities. Also in some cases specific additional penalties have been added. An instance of this has already been given in the case of false reports, where the treasurer is not only liable to the individuals injured by such false reports, but is subject to a prescribed statutory penalty as well, this penalty usually including both fine and imprison- ment. In addition to the common law liabilities, there are in some states penalties for refusal to allow the proper inspection of books; for failure to make certain reports; for permitting stockholders to withdraw any part of their investment in the corporation and for allowing other impairments of the capital stock. Most of the things thus penalized are in themselves morally indefensible. It will be found, however, that occasionally acts or omissions entirely innocent in themselves have, by direct statutory pro- vision, been made punishable offenses. Thus in some states the omission to file certain prescribed reports at a particular time is punished by fine. Statutory provisions of this kind are, how- ever, not numerous and, so far as applicable to the treasurer of the corporation, are restricted almost entirely to the corporate reports. CHAPTER XLIX THE TREASURER'S BOND 461. General The corporate funds are usually placed in the treasurer's care with but little reservation, and, in the absence of special protective provisions, the measure of their safety is the integrity and efficiency of the treasurer. If he is dishonest, they may be stolen; if he is careless, they may be lost. The safeguards that can be thrown round the corporate funds while in the treasurer's custody are but few. Usually he is required to deposit them as soon as they come into his hands, and their withdrawal may be effected only by check signed and countersigned as required by charter, by-laws, or directors' resolution. Notes and drafts likewise usually require signature and countersignature. Regulations as to corporate loans, dis- counts, and other financial transactions restrict his power. Audits of the treasurer's books are held from time to time. His character, standing, and financial responsibility always have much weight. It is obvious, however, that all this affords but very partial protection to the corporate funds, and still less to the other property entrusted to the treasurer's care. One further pro- tective measure of importance exists, and this is the treasurer's bond, the most effective and most relied upon of all the material safeguards possible. 1 The treasurer's bond is an instrument whereby the parties signing it bind themselves within the limits of the bond to make good any losses the corporation may suffer from the negligence, dishonest acts, or wilful omissions of the treasurer. The obliga- i See Book IV, Form 248. 401 402 CORPORATE LAW [Bk. I- tions of the bond are governed strictly by its terms, but the usual personal bond requires: 1. The faithful performance of the treasurer's duties. 2. The safety of the corporate funds and other property entrusted to his care. 3. Their due return on the expiration of his term of office, or at any prior time upon legal demand. 462. Statutory Requirements In many states the statutes are silent on the subject of the treasurer's bond. In a few states, notably New Jersey 'and Pennsylvania, the statutes require that the treasurer be bonded in such sum and with such sureties as the by-laws provide. In other states, as in New York, Colorado, Delaware, Massachu- setts, and Illinois, the statutes are merely permissive and provide that security may be demanded of the treasurer. As to the stockholders, this is merely a restatement of a power already existing. TJiey may, if they wish, provide in the by-laws that a bond shall be required of the treasurer, but they might do this with equal force if the statutes were silent. As to the directors, however, such statutes are of greater weight, giving them, in the silence of the by-laws, the unquestioned right to require a bond from the treasurer a power which otherwise is doubtful. The statutes of the states mentioned are not, however, manda- tory, and if the directors see fit, they may omit the require- ment and cannot be held liable in case of resulting loss to the corporation. 463. Corporate Requirements Irrespective of any statutory provision, the stockholders have full power at common law to require the treasurer to give a bond. Such a requirement might be, and sometimes is, incor- porated in the charter, but is usually found in the by-laws. When the by-laws require a bond, they will sometimes specify its amount and the number of sureties, or perhaps provide in- Ch. 49] TREASURER'S BOND 403 stead that the bond of a reputable surety company shall be given. Usually, however, they merely direct that a bond shall be required of such amount and with such sureties as the board of directors may prescribe. Frequently they are merely per- missive, stating that the board may require the treasurer to give a bond, all details being left to the board. In all cases where the by-laws require a bond of the treasurer, the directors have full power to prescribe any details not covered by the by-law provision. Should neither the statutes nor the charter or by-laws of the corporation require such bond, it is doubtful whether the board would of its own authority have power to compel it. 464. Nature of the Bond The treasurer's bond is a formal undertaking of certain parties who are specified therein and by whom the bond is signed, that in the event of loss arising from the defalcation or other dishonesty of the treasurer, they will make good such loss up to the amount of their bond. When such a bond is given it is usually signed by the treasurer and by his bondsmen as well, and in all cases the details of the liability involved are set forth in full in the instrument. Formerly personal bonds were the rule and the bondsmen were usually friends of the bonded official. Of recent years, however, responsible surety companies supply bonds of the kind, and the personal or individual bond has been largely superseded. The bond of a good surety company is always to be preferred. The personal bond is generally sweeping in its nature, cover- ing any loss occasioned by defalcation or dishonesty on the part of the treasurer and also providing for the proper restoration to the company, when legally demanded or at the expiration of the treasurer's term of office, of all moneys, papers, vouchers, documents, books of account, and other property belonging to the company then in his hands. 404 CORPORATE LAW [Bk. I- The wording of the bond will, however, affect and directly limit the extent of the sureties' liability. Usually bondsmen are not held liable for accidents or mistakes of the principal, or for his inability to perform all the duties of his official position. 2 But where the condition of the bond provides that the principal shall perform all the duties of his office and that the sureties shall pay all damages or losses arising from any failure to per- form such duties, the bondsmen may be held. 3 465. Amount of Bond There is no rule as to the amount of the treasurer's bond. Manifestly the matter is one that must be governed by the conditions of each special case. Its amount is supposed to be proportionate to the risk involved, but frequently it will be fixed haphazardly, or at some arbitrary amount deemed sufficient, or perhaps the cost of the bond will determine its amount. In all cases the bond should be adequate to cover any loss reason- ably possible. The treasurer of a corporation is usually a man of standing and character, and this will in itself have a direct bearing in fixing the amount of his bond. Also he is frequently of some financial responsibility and this will have weight, as the extent of the treasurer's liability is not limited by the amount of his bond. The bond is merely a crystallization of a portion of his liability in convenient shape for ready realization in case of loss for which he is responsible, and any property he may own is available beyond this in case the bond is insufficient. Also some measure of safety is insured by the usual checks existing or placed upon the treasurer's official actions, i.e., the general knowledge of the business and of the treasurer's accounts and affairs possessed by the directors and other corporation officials, the accounts required to be kept, the periodical audits, the 1 Morris, etc., Co. v. Administratrix, 21 N. J. L. 100 (1847); Union Bank v. Clossey, IO Johns (N. Y.) 271 (1813); contra. Am. Bank v. Adams, 12 Pick. (Mass.) 303 (18311. ' Union Bank v. Thompson, 8 Rob. (La ) 227 (1844). , Ch. 49] TREASURER'S BOND 405 prompt deposit of funds, the countersignatures to checks, notes, drafts, etc. All this must be taken into consideration, as must also the general improbability that in event of the treasurer's neglect or dishonesty all the corporate funds and property in his possession will be lost. The bond is usually but a small proportion of the amount entrusted to the treasurer's care when this is at all considerable, and the ratio diminishes rapidly as the amount involved increases. For instance, the treasurer of some small corporation with a cash balance never exceeding a few thousand dollars, will frequently be required to give a bond for a thousand dollars or more. In this case the bond ranges from 25 to even 100% of the total risk. In a large corporation the percentage would be relatively much smaller. Frequently, as stated, the cost of bonding has some weight in determining its amount. Under the personal bond this ele- ment does not enter in, but with the surety Company bond the cost increases with the size of the bond and its amount will naturally be kept as low as prudence will permit. Some- times, with penny-wise economy, its amount is fixed still lower. 466. Personal Bonds As already stated, the bond formerly given by the treasurer was almost invariably signed by individuals. These individuals were usually friends of the treasurer who went on the bond merely as an accommodation to him and without expectation of compensation and equally without expectation of ever being called upon to meet its obligations. If, then, through the treasurer's fault or misfortune, losses occurred and these friends were called upon to make good the undertakings of the bond, they naturally felt the demand to be a hardship. They were legally liable, but they did not feel the moral obligation of a just debt, and would delay payment as long as possible and frequently evade it altogether, or perhaps be found unable to pay. The whole system was, and is, unsatisfactory and ineffective. 406 CORPORATE LAW [Bk. I- The personal bond is still used to a considerable extent, and when it is employed the standing of the treasurer's sureties or bondsmen becomes a matter of the first importance. It is obvious that the value of the bond rests not alone in the financial ability of the bondsmen but to a considerable extent upon their moral responsibility as well, and both their financial standing and general character should therefore, when the bond is large, be subjected to a searching scrutiny. This is a matter entirely within the province of the directors. Usually the bondsmen of a corporation treasurer are personally known to the directors, and the desirability of these bondsmen may then be decided from knowledge so gained without the necessity of special investigation. It need hardly be said that the actual drafting of the instru- ment by which the treasurer's bondsmen are held should be careful and competent. A defective instrument might easily result in a total loss of the protection the bond was expressly intended to afford. 467. Surety Company Bonds The surety company bond is similar in its general nature to a personal bond ; its carefully restricted liability and the fact that it is signed by a surety company instead of by individuals con- stituting the only material difference. The surety companies supplying these bonds are usually well-known and substantial, and the conditions surrounding the issue of their bonds are such as to make the security afforded far superior within its limits to that of the ordinary personal bond. When a surety company bond is desired, the treasurer makes his application in prescribed form, specifying the amount required. The company then investigates the character and standing of the treasurer to decide whether he is a suitable person for the position and one who may be safely bonded. If he is accepted, a fee is paid the company according to the amount of the bond and the nature of the risk, and the bond is issued. Ch. 49) TREASURER'S BOND 407 The treasurer's application to a surety company is formal. It usually involves a very complete statement of his past history and present condition, covering his social and business habits, standing, and connections, and giving all such details of his earlier and present life as will enable the surety company to judge of his fitness as a custodian of money and property. The appli- cant is also required to give a number of suitable references, i.e., people who, while not relatives, have been in a position to judge of the character and responsibility of the applicant. These references are communicated with and a written statement as to the important features of the treasurer's character, reputation, and past history are, if possible, obtained from each. The investigation is usually thorough and searching. If the applicant passes the ordeal successfully, the company issues its bond in accordance with his application. In the case of a corporation treasurer, the surety company's fee for a bond of moderate amount say a few thousand dollars is from $4 to $7 per annum for each thousand dollars of bonded obligation assumed by the company. These fees are sometimes paid by the treasurer himself and sometimes by the corporation. It would seem proper that the corporation should assume this expense, though no established rule prevails. Bonding by a surety company is, as has been said, a strictly business transaction. Before taking the risk the company makes a careful investigation and takes every proper precaution. Its fees are based on careful calculation and long experience and are an adequate payment for the risk assumed. A certain per- centage of loss is anticipated. Then, when loss does occur for which the company is liable under its bond, there is seldom, if ever, any attempt on the part of a reputable and responsible surety company either to evade or delay payment of its obli- gation. Further, it may be said that the reputation and financial standing of the surety companies engaged in the business of bonding may be easily and satisfactorily ascertained; that there 408 CORPORATE LAW [Bk. I- is usually neither trouble nor delay in payment when unques- tioned obligations arise; that in case of doubt, necessitating legal proceedings in order to determine whether or not the bondsmen are liable, the courts construe the bonds given by surety companies much more strictly than in the case of bonds given by individuals, and, finally, that in spite of its limited protection and many conditions, the surety company bond has almost superseded the personal bond. 468. Liability of Bondsmen The contract of the bondsmen or surety company is an agree- ment to indemnify the corporation against loss occurring through the defaults of the treasurer. The treasurer joins with his bondsmen or with the surety company in signing the bond. This is not for the purpose of binding himself to the corporation, to which he already owes a duty, but for the purpose of obligating himself to save his sureties harmless. In bonds prepared by the surety companies the obligation of the surety company is usually made conditional upon the signing of the bond by the treasurer. If the bond is phrased "jointly and severally," the bondsmen signing the instrument are each individually liable to the full amount of the bond, and action in case of loss may, if desired, be commenced against the treasurer alone or against any one of his bondsmen, or against any or all of the parties at the same time. 4 In Massachusetts suit in such case must be brought either against one or against all the obligors. 5 As among them- selves, however, each one of the bondsmen is responsible for his individual proportion of any loss incurred and if payment is enforced from one bondsman, he is legally entitled to collect the pro rata amount due from each of his fellow bondsmen. Usually liability of a personal bond is limited to the amount actually and directly lost by the neglect or dishonesty of the Poullain v. Brown, 80 Ga. 27 (1887); McKee v. Griffin, 60 Ala. 427 (1877); Trustees v. McBride. 81 Misc. (N. Y.) 618 (1913). 5 Leonard v. Speidel, 104 Mass. 356 (1870). Ch. 49] TREASURER'S BOND 409 treasurer. In case the amount of such loss is less than the amount of the bond, the bondsmen are liable only for the loss actually incurred but are still held on the bond for any future losses and this liability continues until the bond expires or until they have paid out the full amount of their obligation there- under. If the loss is greater than the amount of the bond, the bondsmen are liable up to its full amount but not beyond, and upon payment of its amount the bond is extinguished and of no further effect. In other words, the amount specified in the bond marks the limit of the bondsmen's liability. When a bond is once executed the bondsmen cannot with- draw or escape from its liability until the legal termination or prior cancellation of the bond. They may have reason to sus- pect the treasurer of dishonesty or carelessness, or for other reasons may greatly desire to end their liability, but this they cannot do unless with the consent of the corporation. They may neither cancel their obligation nor escape it. 6 They can only wait until time works their relief or perhaps their ruin. A cancellation clause is sometimes inserted in personal bonds, and always in surety company bonds, for the express purpose of its termination, if desired, before the end of the bonded period. The undertaking of a bond is an onerous one that should not be entered upon by individuals as lightly as is usually done. The expectation is, of course, that no loss will occur and no active obligation fall upon the bondsmen. Instances showing the fallacy of this expectation are, however, numerous, and when liability does arise, the results are apt to be serious too serious to justify the signing of a bond as a mere matter of friendship, when a few dollars will, as a matter of ordinary business, obtain perhaps a better bond from a responsible surety company. A personal bond is an imposition on the individuals, and does not safeguard the corporation. In case of doubt, or when legal proceedings are necessary to enforce the liability of bondsmen, the courts, as already stated, * Stearns on Suretyship, f 119. 410 CORPORATE LAW [Bk. I- construe the bonds given by surety companies much more strictly than the bonds of individuals. The leniency shown the indi- vidual in this case arises from the fact that he generally takes no part in the writing of the instrument and does not profit from the transaction. He is in fact merely an accommodation party and is therefore entitled, in case of doubt, to the strictest con- struction in his favor. 7 In the case of a surety company, the reverse of all this is true. The company itself prepares the form of bond, carefully investigates and limits the risk it assumes, protects itself in every particular, and is paid adequately for its undertaking. Hence, when the courts pass upon such a contract, their construction in case of doubt is against the surety and in favor of the party seeking indemnity. 8 469. Termination of Bond Unless the treasurer's bond contains some clause providing that its liability shall continue, or sooner terminate, it is limited to the term of office fonwhich the treasurer was elected. If the treasurer is re-elected, his bond, unless specifically so provided in the instrument, does not pass over to the new term but must be renewed. 9 Also, if the election of officers fails and the treasurer holds over beyond the elected term,- his bondsmen are not responsible for this hold-over term unless this continuing responsibility is clearly expressed in the bond. 10 The death of the treasurer terminates his bond, as does like- wise his peremptory or accepted resignation, provided in either case that all the corporate funds and other corporate property entrusted to him are returned. Also, if there is any material change in the duties and responsibilities of the treasurer, the old * Stearns on Suretyship, J 255; Ulster Co. Sav. Inst. v. Ostrander, 15 App. Div. (N. Y.) 137 (1897); Ward v. Stahl. 81 N. Y. 406 (1880). "Am. Surety Co. v. Pauly, 170 U. S. 133 (1897); Tarboro v. Fidelity Co.. 128 N. C. 366 (1901). 9 Citizens' Loan Assn. v. Nugent, 40 N. J. L. 215 (1878); Savings Bank v. Hunt, 72 Mo. 597 (1880); Ulster Co. Sav. Inst. v. Ostrander, 163 N. Y. 430 (1900). 10 Brandt on Suretyship, 191; Ulster Co. Inst. v. Young, 161 N. Y. 23 (1899). Ch. 49) TREASURER'S BOND 411 bond may be terminated or vitiated by the changed conditions and a new bond should then be required. 11 It is to be noted that while the liabilities of a bondsman are limited to losses occurring during the term for which the bond is given, the bondsmen are not released entirely at the end of this period, but may still be held for any defalcation or loss which occurred during the bonded term, even though such loss were not discovered until long after this term expired. In other words, the bondsmen undertook to make good certain possible specified losses if they occurred during a certain specified time, i.e.,- during the treasurer's term of office. If such losses do occur, the mere fact that they are not discovered till later does not affect the liability of the bondsmen one way or the other, unless perhaps the bondsmen's liability is then barred by the statutes of limita- tion, or some limitation has been imposed by the terms of the bond. It has been held that defalcations in three successive years under an original bond and two renewals were recoverable, although the total amount was greater than the liability of the bond for any one year. 12 This continuing liability is a disturbing feature of the personal bond and is a strong reason for its avoidance. In a surety com- pany bond, on the contrary, this feature is taken into considera- tion and provided against by careful limitations. National, etc. Assn. v. Conkling, 90 N. Y. 116 (il<82); Smith v. Molleson, 148 N. Y. 241 (1896). " Campbell Milk Co. v. U. S. Fidelity & G. Co., 161 App. Div. (N. Y.) 738 (1914). CHAPTER L THE TREASURER'S REPORTS 1 470. The Report to Directors In the smaller corporations the directors usually keep in close touch with both the corporate business and its records, and a formal report from the treasurer will hardly be required more than once a year. In the larger corporations monthly reports showing the con- dition of the corporate affairs are usually required, the details and scope of these reports depending somewhat on the nature of the corporate business. An annual report is also made at the end of the corporate year, usually similar in form to the monthly reports but covering the operations of the entire year. There should be no reservations in the treasurer's report to the directors. The directors are responsible for the management of the business and should be fully informed on every detail of the corporate operations that will assist them in the intelligent and capable discharge of this responsibility. Occasionally it will happen that special transactions are not divulged to the entire board of directors, but this is exceptional and is proper only when the directors themselves concur. The treasurer's report, whether monthly, quarterly, or an- nual, should, for the period covered, give the source and amount of moneys received, the amount and nature of disbursements, the earnings and expenses, and the assets and liabilities as of the close of the reported period. Any special data peculiar to the particular time or period, or of importance to the financial operations of the corporation, should also be embodied in the treasurer's report. 1 See generally. Book III, Part VII, "Corporation Reports and Statements " 412 Ch. 50] TREASURER'S REPORTS 413 The form and the details of the report submitted depend on the requirements of the board and also on the possibilities of the accounting system. If profits can only be ascertained annually or semiannually after taking an inventory, then the monthly report cannot embody an accurate balance sheet or a profit and loss statement. A summarized statement of cash receipts and disbursements can always be made and such statistical data as gross sales, returns, purchases, etc., can be presented if desired. If made in a comparative form, i.e., if the data of the corre- sponding year are also inserted, the directors will be able to draw some valuable conclusions. Frequently, when possible, a com- parative balance sheet is also submitted showing the assets and liabilities as at the close of the month of the report. "Usually a comparative profit and loss statement is made up, showing the earnings and expenses for the corresponding month of the previous year. The expenses are not detailed in this statement, reference being made to the analysis book which shows in comparative form the detailed expenses of each month. This book should accompany the report when it is submitted to the directors. This obviates the necessity for detailing all ex- penses in the report, which should be done if an analysis book is not kept or is not presented to the board. The treasurer's annual report to the directors should follow the general form of the monthly report. 471. Report to Stockholders The stockholders compose the corporation and are entitled to information as to its condition and progress. Frequently, however, there are trade reasons for withholding the more con- fidential details from them. It is obvious that if a full showing of the corporate business and the results of its operations were made annually to the stockholders of a corporation, it would become public property and serious results might follow. Pri- marily for this reason, but also because the stockholders do not need nor usually desire fully detailed statements of the 414 CORPORATE LAW [Bk I- corporate business, the reports made to the stockholders are almost always general in their character. The report to the stockholders generally takes the form of a statement of earnings designed to give a view of the company's operations. Sometimes a condensed balance sheet will make an excellent stockholder's report. This may be accompanied by an income tax statement showing the earnings for the year, and also by a condensed general profit and loss account. In many of the larger corporations, more or less directly connected matter accompanies the balance sheet. 2 In many corporations the treasurer makes no independent report, the president's report covering the general affairs and conditions of the corporation together with its finances and plans for the future. This is true, for instance, of the United States Steel Corporation, where but one formal report that of the chairman of the board is made to the stockholders. In perhaps the majority of cases, however, the treasurer makes his own report to the stockholders, covering in it such details of the financial affairs of the corporation as the directors deem it expedient for the stockholders to know; or, to express it other- wise, all such financial details as will be of interest to the stock- holders, the publication of which will not result in injury to the company's business. Where but one formal report is made to the stockholders and this report is made by the president, the treasurer or the treasurer's department will, of course, supply the president with material for the financial portion of the statement. In any case, the two officials should work in sufficiently close touch to pre- vent any serious overlapping of their reports. 3 *See Book IV, Forms 264, 265. See Book IV, Form 262. Part XI The Corporate Finances CHAPTER LI THE CORPORATE FUNDS iiiv/y, ,':UK ;/ 472. General "Corporate funds" is a general term applied to the moneys belonging to the corporation. Technically, the term "funds" includes securities as well as moneys, but used in connection with the treasurer's work it is customary to restrict its applica- tion to cash, sight drafts, checks, and similar readily convertible paper. The general corporate securities, such as notes, time drafts, treasury stock, bonds, securities of other corporations, etc., are also usually committed to the treasurer's care but not under the designation "funds," the provisions regulating the matter usually employing the phrase "money and securities," in order to avoid any uncertainty as to their scope. 473. Collections Whether the treasurer is responsible for the collection of moneys due the corporation or not, is a matter determined entirely by the requirements or practice of the particular cor- poration. In the smaller corporations collections falling due in the ordinary course of business are within the usual province of the treasurer; in the larger corporations they are not. In these all moneys as received are turned over to the treasurer, but his responsibility as to collections is limited to such special collections as may be specifically assigned to him. 415 416 CORPORATE LAW [Bk. I- 474. Status of Treasurer as to Corporate Funds In receiving and holding the corporate moneys the treasurer acts as the agent of the corporation. He must therefore safe- guard them with all reasonable care, and use them only on account of and for the benefit of the corporation and in accord- ance with its instructions. So long as he acts within these limits, he is not responsible for any losses which may occur. 1 If, however, the treasurer fails to use reasonable care in his custody of the corporate funds, i.e., the care that a prudent man of business would exercise in regard to his own funds, he will be liable for any resulting losses. Also, if he disburses, uses, or invests the corporate funds without authority, he is again liable if losses result, but, should gains be made, these gains belong to the corporation. In other words, any profits resulting from the use of the corporate funds while in the treasurer's care, belong to the corporation regardless of whether such use be proper or improper. If losses result from proper use of the funds the loss is the corporation's; but if the use be improper, the loss is the treasurer's. This same rule holds good where the treasurer privately employs corporate funds for his own benefit or account. If the transaction is discovered, the corporation can reclaim not only its funds but any resulting profits as well. If losses occur, the treasurer can be required to make these good and in addition, in either case, is liable to prosecution for embezzlement. Such a condition occasionally occurs where the cashier or treasurer of an institution uses its funds for speculative purposes, expecting to replace the borrowed funds from the returns of the venture, while any profits are to be retained as his own private gain. Usually no profits are made and the discovery of the transaction involves the defaulting treasurer in disgrace and punishment. If, however, profits should be made, these profits are the property of the corporation and, if retained by the treasurer, his offense is twofold. Not only has he used and First Nat. Bank v. Bank, 77 N. Y. 320 (1879). Ch. 51] THE CORPORATE FUNDS 417 risked the corporate funds improperly, but he has stolen the resulting profits. 475. Custody of Corporate Funds The treasurer's responsibility for the corporate funds begins as soon as they are turned over to him, and continues until they are surrendered to his successor or to some other properly authorized party. Usually the corporate authorities designate a depositary and require the treasurer to deposit the corporate funds 'therein. If not, it would still, as a rule, be the duty of the treasurer to deposit in a reputable bank the moneys coming into his hands, as an incident of the "reasonable care" properly required of him. Just how soon funds should be deposited after their receipt is a matter to be decided by conditions. Usually a routine for handling the corporate moneys and securities is established and the treasurer is governed by its rules. In the absence of any express provision or custom requiring daily deposits, small amounts of money might properly be held until a convenient time for depositing them, particularly if there were a suitable safe or vault at the treasurer's disposal in which such funds* could be kept. If, however, material amounts of money were received by the treasurer during banking hours, he would ordinarily be grossly negligent if they were not deposited the same day. If received after banking hours, they should be kept in the safest place at his command until they can be de- posited on the next banking day. The temporary receptacle for such funds would naturally be the safe or vault used by the corporation for the preservation of its books, papers, and other valuables. Should the treasurer place his funds elsewhere, a very clear and satisfactory explanation of his reasons for so doing would be necessary to save him from liability in case of any resulting loss. In the larger or more active corporations considerable amounts of money are often kept over from day to day in the 418 CORPORATE LAW [Bk. I- various funds or for special purposes, but they are kept under such conditions of safety as to render the risk negligible. Also, as this is done with intent, and with the knowledge and consent of all parties concerned, the treasurer is not liable even though losses occur. The general rule that the corporate funds should be deposited promptly applies particularly in the case of checks. The check is merely an order for money, and if the treasurer accepts this order and does not present it promptly for payment, he is himself liable for any loss occasioned by the delay. 2 476. Disbursement of Corporate Funds The disbursement of the corporate funds is usually made under carefully prescribed conditions, and the treasurer can hardly incur liability in the exercise of this duty save as a result of gross negligence or downright fraud. Usually the by-laws provide that the corporate funds shall be paid out by the treasurer in accordance with the instructions of the directors, and also prescribe the exact signature to the checks by means of which payments are made, and require that the treasurer shall take all proper receipts and vouchers. If the by-laws are silent, the directors have full power to make such rules as to disbursements as they deem proper. If neither by-laws nor directors' resolutions make any pro- vision as to the details of disbursements, the treasurer may then use his discretion and need only observe the rules of ordinary business. These would undoubtedly require that payments of importance be made by check whenever reasonably possible, and that receipts or vouchers be taken for all moneys paid out. In no event has the treasurer authority to make payments on his own initiative. The matter is one that belongs to the directors alone and the treasurer has no right either to make a payment without their authorization or to refuse a payment when it has been directed by them. Smith v. Miller, 43 N. Y. 176 (1870); First Natl. Bank v. Bank, 77 N. Y. 320 (1879) Ch. 51] THE CORPORATE FUNDS 419 The payments of corporate funds customarily made by the treasurer in practice without specific authorization are not in violation of this rule. Occasionally he will in an emergency or for special reason pay accounts without authorization of any kind, but he then relies upon the acquiescence or express ratifica- tion of the directors. Usually, however, his payments, when not specifically authorized, are made under blanket instructions empowering the payment of large amounts made up of numerous small items. Or perhaps certain routine obligations, as the pay-roll at the end of each week, will be paid as a matter of course, the treasurer relying entirely upon the implied authority of custom. The treasurer's responsibility for the correctness and validity of accounts paid depends upon the conditions. If bills are ordered paid by the directors, the treasurer ordinarily has no responsibility in the matter save for their proper payment, unless he is aware of doubtful or fraudulent circumstances connected with these accounts not known to the directors. If, however, under a general authorization he pays accounts which later prove to be false or fraudulent, he might be held for any resulting loss. To escape it he must show that he was unaware of, and could not have been reasonably expected to discover, the fraudu- lent nature of the accounts. 3 477. Return of Corporate Funds At the conclusion of the treasurer's tenure of office, it is his duty to turn over the corporate funds to his successor or to such other party as may be designated by the board of directors. If he does not do this voluntarily, their return may be enforced by legal action.* If any deficiencies are discovered in the funds, the treasurer or his bondsmen must make them good, and if such deficiencies occurred through the treasurer's wrongdoings, he is liable to a criminal action. See Ch. XLVIII, "The Treasurer's Liabilities." 'Hunter v. Robbins, 117 Fed. Rep. 920 (1902); Consolidated, etc., Works v. Brew., 113 Wis. 610 (1902). CHAPTER LII DIVIDENDSi 478. Declaration of Dividends The right of the directors to declare dividends is an incident of their general power to manage the affairs of the corporation, and is recognized either directly or by implication by the stat- utes of every state. The right is subject to provisions of the charter or by-laws regulating the declaration of dividends, and to any provisions of the statutes applicable thereto. The by- laws almost invariably specifically authorize the declaration of dividends by the board of directors. An example of compre- hensive by-law provision follows: The Board of Directors may declare dividends from the surplus or from the net profits of the Company. The dates for the declaration of dividends upon the preferred stock and upon the common stock of the Company shall be the days by these By-laws fixed for the regular monthly meetings of the Board of Directors in the months of April, July, October, and January in each year, on which days the Board of Directors in its discretion shall declare what, if any, dividends shall be declared upon the preferred stock and the common stock, or either of such stocks. The dividends upon the preferred stock, if declared, severally and respectively, shall be payable quarterly upon the thirtieth day of May, of August, of November, and the last day of February in each year. The dividends upon the common stock, if declared, severally and respectively, shall be payable quarterly on the thirtieth day of June, of September, of December, and of March in each year. 2 * See also Book II, Chs. XXXI, XXXII, "Dividends"; also Book III. Ch. XIV, "Divi- dends." 2 By-Laws of the U. S. Steel Corporation, Art. VI, 5, "Dividends." 420 Ch. 52] DIVIDENDS 421 In the smaller corporations the by-laws regulating dividends are much more general in their provisions, usually merely re- stating the common or statutory law on the subject, as in the following extract: Dividends shall be declared only from the surplus profits at such times as the Board shall direct, and no dividend shall be declared that will impair the capital of the Company. Under this by-law the directors have wide discretion and, provided no statutory provisions conflict, may reserve any profits they please for surplus or working capital, or may declare any legally available profits as dividends, and, so long as the exercise of their discretion is honest, can be neither restrained nor compelled. Statutory provisions prohibiting dividends that will impair the capital stock or that will render the corporation insolvent are found in practically every state. It is but seldom that the statutes go further in respect to dividends. In New Jersey, however, there is a certain unique statute that compels directors to pay dividends if there are any corporate profits, unless the charter or by-laws provide otherwise. Hence it is necessary for New Jersey corporations, either in charter or by-laws, to prescribe that directors may make reserves and accumulate working capital. The by-laws frequently regulate the declaration of dividends. In some cases they provide that a specified surplus fund shall be reserved before any dividends may be declared. In other cases they specify that, after the reservation of a designated surplus, any remaining profits shall be declared as dividends. Occasionally the matter is reversed, the by-laws requiring that dividends to a specified amount shall be declared before any profits may be reserved as surplus. Such a by-law provision is, as a rule, obviously undesirable, since it compels the declara- tion of dividends regardless of the business conditions which should control. 422 CORPORATE LAW [Bk. I- Usually, before the date fixed for declaration of dividends or, if no such date is fixed, at the time a dividend is contemplated, the treasurer is called upon for a statement showing the cor- porate profits available for the purpose. If, however, the cor- poration has ample surplus profits, or if the business is so prosperous as obviously to justify the proposed dividend, no statement is necessarily required, the directors merely declaring the dividend as a matter of course. 479. Resolution Declaring a Dividend When the fact and the amount of the dividend have been decided upon, a formal resolution declaring it is adopted by the directors. This resolution usually fixes specifically the amount of the dividend and states to whom and when it shall be paid. 8 The amount is ordinarily expressed as a percentage upon the par value of the stock, though sometimes as a fixed amount per share. The recipients must necessarily be stock- holders of the company, but are usually stockholders of a specified future date, and the time of payment is usually fixed at a still later future date. Thus, a semiannual dividend declared by the Pennsylvania Railroad Company November i, provided for a payment of 3^% upon the capital stock of the company, payable on and after November 30 to stockholders as registered upon the books of the company at the close of business November 4. In the notice of this dividend the statement of the amount on each $50 share, i.e., $1.75 per share, is also included. The directors have full power to declare a dividend ^effective at any future date they please. They cannot, however, antedate it. Thus, the directors could not on January 2, 1917, legally declare a dividend payable to stockholders of record on the 1 5th of the preceding October. 4 The power to do so would, it is obvious, open a wide door for injustice and fraud. 3 See Book IV, Forms 140-151. Jones v. Terre Haute, etc., R. R., 57 N. Y. 196 (1874). Ch. 52] DIVIDENDS 423 If the treasurer is a member of the board or is present at the board meeting, the passage of the resolution declaring the dividend is undoubtedly sufficient notice to him of the fact and he is then authorized to carry the resolution into effect. If the treasurer is not present at the board meeting, a verbal statement made to him by a member of the board or by the secretary of the company is a common, but in itself hardly sufficient, notice of the board's action. A personal inspection of the resolution entered in the secretary's minutes is better, and though informal is sufficient. Written notice from the sec- retary of the passage of the resolution, with a copy of the resolution itself incorporated, is more formal and may, if he chooses, be demanded by the treasurer. As soon as the treas- urer has authoritative notice of the resolution, no matter how his knowledge is derived, he may proceed at once to the pay- ment of the dividend in accordance with its terms. The resolution declaring a dividend usually provides for the closing of the stock books to transfers of stock for a certain period before the dividend day, i.e., the day when the dividend is to be paid. This provision for closing the transfer books is usually and properly part of the charter or by-law requirements of the corporation. It is questionable whether the directors would have power to close the transfer books unless so authorized. 480. Profits and Dividends Profits are the only proper source of dividends. The dec- laration of dividends when there are no profits is contrary to law, usually involves a personal liability by the parties respon- sible, and in many states involves a cfiminal liability as well. If an illegal dividend is contemplated, any stockholder may enjoin its declaration or payment, and, should the company become insolvent, the stockholders who receive such dividends may be compelled to make restitution. 5 '2 Cook on Corp., 55 547. 548; Stevens v. U. S. Steel Corp., 68 N. J. Eq. 373 (1905); 'ricke v. Angemeier, 101 N. E. (Ind.) 329 (1013). 424 CORPORATE LAW [Bk. I- The general rule in this country is that before dividends can be properly declared, any impairment of capital through business losses in previous years or through depreciation, must first be made good. In other words, dividends must be declared out of "surplus." 6 As it is stated in a Missouri case, "dividends can properly be declared only from the profits over and above the capital stock and the debts of the company. 7 Before de- claring a dividend the directors should examine carefully the financial condition of the company and the statutory provisions regulating the declaration of dividends in the state of incor- poration. An exception to the general rule that dividends impairing the capital stock may not be paid, is found in the case of com- panies working mines or operating under leases, patent rights, etc. Here the corporation is organized for the express purpose of working out the property which is represented by its capital stock and the impairment and final exhaustion of this property is the object of the corporate operations. In any such case 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 work- ing it from being divided amongst the shareholders, and this, in my opinion, is true although some portion of the property itself is sold and in some sense the capital is thereby diminished. 8 The decision in the English case from which the foregoing quotation is taken, has been generally followed in this country and is regarded as establishing the rule. It must, however, be noted that in this case the assets of the company were ample Williams v. Western Union Telegraph Co., 93 N. Y. 162 (1883); Roberts v. Roberts- Wicks Co., 184 N. Y. 257 (1906); Thompson on Corp., { 5312. 7 Shields v. Hobart, 172 Mo. 491, 517 (1902). Lee v. Neuchatel Asphalte Co.. L. R. 41 Ch. D. I (1889). Ch. 52] DIVIDENDS 425 and there was no question of insolvency or charge of indis- cretion in the declaration of dividends which formed the basis of litigation. A difficulty sometimes arises when determining the cor- porate profits for dividend purposes, as to what expenditures may properly be charged to capital stock account and what should be charged to current expenses. Thus, if a manufac- turing concern purchases machinery and this is charged to capital stock account, the books will show a larger net profit for the year than if the item is charged to expense account. The matter is one of bookkeeping and the actual assets of the company are not affected in either case, but its profits legally available for dividends are directly increased or diminished according to the account to which the item is debited. This question usually arises when the directors are anxious to divert every possible penny into dividends. The problem is a difficult one and its solution will vary with the conditions. "It may be safely said that what losses can be properly charged to capital and what to income is a matter for business men to determine and it is often a matter on which the opinions o\ honest and competent men will differ. 1 " 9 Speaking generally, only those expenditures for which stock or bonds might be issued with propriety can be properly charged to capital account. 481. Equality of Dividends Dividends, as stated, are usually declared as a percentage upon the outstanding capital stock, or as a certain amount on each class of stock, and each stockholder in any class of stock participates according to the stock he holds. This rule is absolute. When they (the directors) undertake to declare a dividend, they are bound to make it equal and just among all who are interested. They would have no right to divide their profits among a few par- ticular friends, neither would they have authority to say that one Gregory v. Patchett, 33 Beav. (N. Y.) 595 (1864). 426 CORPORATE LAW [Bk. I- class of stockholders should receive a larger amount of the profits or a greater dividend than others. They are but the agents of the stockholders. The profits belong to the stockholders and they must apportion them fairly and justly with due regard to the interests of each and all of them. They cannot make an unjust discrimination, giving one an advantage over another. If they do this, they exceed their powers and the courts have a right to interpose their authority to prevent it. 10 The general rule of equality applies, however, only to stock- holders of the same class. In the organization of a corporation, or later if the proper formalities are observed, different classes of stock may be created and these may be given different divi- dend rights. 11 Thus, preferred stocks are frequently created with preferential dividends which they receive before other classes of stock receive anything at all. The difference is, how- ever, one that was intended and one that is clearly set out in the provisions by which- the preferred stock is created; and as it is understood and by implication agreed to by every stock- holder of the corporation, no injustice results. As between the members of any one class, however, divi- dends must be paid with absolute impartiality. The number of shares of stock each holds must determine the amount re- ceived by him when dividends are paid. The time of payment and the method of payment must be the same for all. Some, unless by consent or agreement, cannot be paid in cash while others are paid in stock or scrip. All must fare alike. 12 482. Compelling the Declaration of Dividends The declaration of dividends rests entirely in the discretion of the board unless otherwise provided by statutes, charter, or by-laws. 13 It is but seldom that the stockholders can compel "Luling v. Atl. Mut. Ins. Co., 45 Barb. (N. Y.) 510 (1865); Miller, J. " See Ch. XI, "Preferred Stock"; also Book II, Ch. VI, "Preferred Stock." 12 Jones v. Terre Haute, etc., R. R., 57 N. Y. 196 (1874); State v. Bait., etc., R. R., 6 Gill (Md.) 272 (1848); Godley v. Crandall & Godley Co., 153 App. Div. (N. Y.) 697 (1912). Hunter v. Roberts, Throp & Co., 83 Mich. 63 (1890); Burden v. Burden, 159 N. Y. 287 (1899); New York, etc., R. R. v. Nickals, 119 U. S. 296 (1886). Ch. 52] DIVIDENDS 427 the directors against their judgment to declare a dividend, even though liberal reservations of profits are being made for working capital or as a surplus fund for future contingencies. The courts have, no doubt, in many cases overruled the di- rectors who proposed to pay dividends, but I am not aware of any case in which the court has compelled them to pay when they have expressed their opinion that the state of the accounts did not admit of any such payment. 14 There is, however, a point at which the courts will intervene to prevent undue or improper retention of profits. The directors must act in good faith. If they fail to do so and it clearly appears that they have accumulated earnings not required in the prosecution of the business which they withhold from the stockholders for illegitimate purposes, a court of equity may interfere and compel a distribution of such earnings. 15 Courts of equity will not interfere in the management of the directors unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate funds or refuse to declare a dividend when the corporation has a surplus of net profits which it can, without detriment to its business, divide among its stockholders, and when a refusal to do so would amount to such an abuse of discretion as would constitute a fraud or breach of that good faith which they are bound to exercise towards the stock- holders. 16 'A . 483. The Case of the Ford Motor Company An interesting and unique case was the suit of certain stock- holders against the Ford Motor Company, to force the directors to pay out part of its large surplus in dividends instead of carrying out the more altruistic ideas of the founder of the business. "My ambition," said Mr. Ford, "is to employ still more 14 Bond v. Barrow, etc.. Co., 86 L. T. Rep. 10 (1902). " Matter of Rogers, 161 N. Y. 108 (1899); Wilson v. Am. Ice Co., 206 Fed. 736 (1913); Gehrt v. Collins Plow Co., 156 111. App. 98 (1910); Spear v. R. R. Lime Co., 93 Atl. (Me.) 754 (I9IS). " Hunter v. Roberts, Throp & Co., 83 Mich. 63 (1890). 428 CORPORATE LAW [Bk. I- men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this we are putting the greatest share of our profits back in the business." The court said: It is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the mere in- cidental benefit of shareholders, and for the primary purpose of benefiting others, and no one will contend that, if the avowed purpose of the directors was to sacrifice the interests of share- holders, it would not be the duty of the courts to interfere. It appeared that the company paid 60%, or $1,200,000 on its capitalization of $2,000,000, leaving some $58,000,000 to be reinvested. The decree of the court required the directors to declare an additional dividend of over $19,000,000, which decree the highest court of Michigan unanimously affirmed. 17 484. Dividend Rights of Preferred Stockholders Cases sometimes arise, however, where a refusal to declare dividends, even where apparently reasonable on its face, is inequitable because of the conditions. For instance, preferred stock not infrequently carries non-cumulative dividends, and if these dividends are not declared in any year, they are lost to the preferred stock entirely. It is obvious, then, that if profits exist from which the dividends might be paid but the directors, instead of declaring these dividends, carry them over in surplus until the following year, the preferred stock has been juggled out of a dividend that properly belongs to it and there is a distinct advantage to the holders of the common stock. Thus, if a company has a capitalization of $200,000, of which $50,000 is preferred, non-participating stock carrying a 7% non-cumulative dividend, and the remainder is common stock, and tHe directors pay no dividends for five years although profits sufficient to pay the preferred dividends were made, these 17 Dodge v. Ford Motor Co., 204 Mich. 459 (1919). Ch. 52] DIVIDENDS 429 dividends, amounting to $17,500, are lost absolutely to the preferred stock. Then in the sixth year the directors, should they so desire, might declare a 7% dividend on the preferred stock amounting to $3,500, which is all the preferred stock is entitled to for that year, and thereafter declare the entire re- maining profits as a dividend on common stock. This latter then receives $14,000 that really belongs to the preferred stock. In cases of this kind the courts are much less reluctant to intervene and will usually compel payment of the dividends on the preferred stock for any year if satisfactory proof is adduced that profits exist sufficient for the purpose which can be used without injury to the corporation. Even here, however, the court scrutinizes the condition of the corporation closely and refuses the dividend unless it is clearly and unmistakably with- held wrongfully and to the injury of the preferred stock. 18 485. Status of Declared Dividends When a dividend is once declared it becomes a debt of the corporation and stands on a parity with its other debts. Should the corporation become insolvent before such dividend is paid, the stockholders take their place among the other creditors of the corporation and may enforce their claims as would any other corporate creditor.^ Further than this, if the money to pay a declared dividend is set aside in a separate fund -for the purpose, even though merely placed on deposit, it has been held that this particular fund becomes the absolute property of the stockholders a trust fund held by the corporation for their benefit and, provided only that the dividend is legal and the fund is set aside in good faith, such fund cannot be reclaimed by the corporation nor is it liable to taxation or for the corporate debts. 20 However, 18 Belfast, etc. R. R. v. Belfast, 77 Me. 445 (1883); Wilson v. Amer. Ice Co., 206 Fed. Rep. 736 (1913). "Hunt v. O'Shea, 69 N. H. 600 (1899). > Pollard v. First Nat. Bk., 47 Kans. 406 (1891); Searles v. Gebbie, 115 App. Div. (N. Y.) 778 (1906). 430 CORPORATE LAW [Bk. I- "simply declaring a dividend does not create a trust fund. To create such a fund some specific sum of money must be set apart for paying the dividend. Until this is done, the relation of the corporation to its stockholders in respect to dividends is that of debtor and creditor. "21 A dividend does not, however, become an irrevocable fact until notice of the resolution declaring it has been given or the fact that it has been adopted has become known. If the direc- tors have voted the dividend but the fact has not been made public in any way, the action may be rescinded. 22 Also, under some circumstances a formally declared divi- dend may be revoked. Thus, should the board declare a divi- dend in defiance of or in ignorance of facts which make it illegal, the action of the board may be rescinded at any time before payment of the dividend has actually been made. 23 As a declared dividend is a debt due from the corporation to the stockholder, any real existing indebtedness of the stock- holder to the corporation may be set off against the dividend and be deducted from it, provided the debt is actually due at the time the dividend is payable. Accordingly the corporation has full power to apply dividends in payment of subscriptions due on its stock from the stockholders. 24 It may be noted that a contract between the corporation and a subscriber to its stock that his subscription shall be paid for hi dividends, is absolutely invalid both as against the cor- poration and against corporate creditors. Under such an agree- ment any credits of declared dividends actually made would be held a valid payment, but in case of the insolvency of the corporation before the stock was full-paid, the stockholder could be called upon to pay in cash all amounts still due on his sub- scription, regardless of the agreement. 25 21 Hunt v. O'Shea. 69 N. H. 600 (1899). Ford v. Easthampton Rubber Thread Co., 158 Mass. 84 (1893). a Marquard v. Federal, etc., Co., 95 Fed. Rep. 725 (1899). "Kenton, etc., Co. v. McAlpin, 5 Fed. Rep. 737 (1880). "Hawkins v. Citizens', etc., Co., 38 Ore. 544 (1901). CHAPTER LIII DIVIDENDS (CONTINUED) 486. Form of Dividends Dividends are usually paid in cash and, unless otherwise stated, cash payment is always understood. Dividends may, however, be declared from existing profits regardless of the form of these profits. "The surplus may be in cash and then it may be divided in cash; it may be in property, and if the property is so situated that a division thereof among the stockholders is practicable, a dividend in property may be declared, and that may be distributed among stockholders." Also, if the profits are not in the form of cash and not in a form to be distributed directly as property among the stockholders, the property might be sold or be used as a basis for a loan of cash to be used in payment of dividends; or scrip, bonds, or stock might be issued against it as dividends.* 487. Distribution of Profits as Salaries Another method of disbursing profits occasionally practiced, is that of paying these profits to the officers of the corporation under the guise of salaries. The excess amount of these salaries represents the dividends that would otherwise be declared. It is obvious that this practice is proper only when all the stock- holders are also officers of the corporation or consent to the other- wise excessive salaries. "So long as all the parties in interest, incorporators, stockholders, directors and officers, assented to the scheme for the distribution of assets by the payment of salaries, the plan was not objectionable." 2 But if any interested i Williams v. W. U. Tel. Co., 93 N. Y. 162 (1883). See also Book II, Ch. XXXII, "Payment of Dividends." 2 Fitchett v. Murphy, 46 App. Div. (N. Y.) 181 (1899). 431 432 CORPORATE LAW [Bk. I- parties do not consent, the plan becomes not only objectionable, but illegal. What has been said on this subject might be considered as modified by the federal income tax law of 1918, which provides: That in computing net income there shall be allowed as deduc- tions: (i) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, in- cluding a reasonable allowance for salaries or other compensation for personal services actually rendered. This would seem to prevent, and was intended to prevent, the distribution of profits as salaries. Salaries are limited to "a reasonable allowance" and to "personal services actually rendered" and they must be reasonable under all the circum- stances. Under former conditions, in many cases officers in close corporations were content to work for nominal salaries. Now, as corporate incomes are taxed at a much higher rate than or- dinary personal incomes, such officers naturally desire to make their salaries as high as they can legally. The situation is a diffi- cult one and it is not easy to give any rule that is really helpful in actual practice. The problem of determining reasonable compensation for per- sonal services is one of difficulty, in that there are few general rules which can be laid down as guides to a decision. Many factors are involved, among them being the character and amount of respon- sibility, ease or difficulty of the work itself, time required, working conditions, future prospects, living conditions of the locality, in- dividual ability, technical training, profitableness to the employer of the services rendered, and the number of available persons capable of performing the duties of the position. These and other factors have a bearing, and the amount of weight to be attached to each one can be determined only in the light of the circumstances in each particular case. 3 Bulletin 10, 1919, Income Tax Ruling No. 362; Advisory Tax Board Memorandum No. 44- Ch. 53] DIVIDENDS 433 In but few cases have the courts been called upon to pass on these matters. An authority on income tax matters writes: In the opinion of the author the courts will not disallow any compensation, no matter how unreasonable it appears to be on the surface, and no matter how large it seems to be compared with the amounts paid by other concerns, unless the payment is proved to be merely a dimsim of profits distributed proportionately to stock- holders.* 488. Cash Dividends The simplest form of dividends are those paid in cash. Such dividends are usually declared and paid from cash profits on hand. If, however, the profits of the company exist in some other form of property, the directors may, as already stated, sell such property and use the proceeds for the cash payment of dividends, or may borrow the cash on the security of this property or on the general credit of the corporation and pay the dividends from the money thus obtained; or they may, under proper conditions, issue stocks, bonds, or scrip against the property and secure cash for the payment of dividends from the sale of these securities. 489. Dividends Not in Cash If corporate profits available for dividends are in the form of property and the directors do not care to sell or encumber this property, or if they wish to reserve the cash profits for the use of the corporation, dividends may be declared in several different forms: 1. The capital stock may be increased and this increase be distributed as a stock dividend, or any unissued or treasury stock on hand may be used for the purpose. 2. Bonds may be issued to the amount of the dividend and these bonds be distributed. 4 Montgomery on Inc. Tax Proc. (1921), p. 688. 434 CORPORATE LAW [Bk. I- 3. Scrip may be issued against the profits and the scrip be distributed as dividends. rdi - u 4. If the property is in such shape as to permit, it may itself be distributed as a property dividend. Dividends in all these different forms, if issued under proper conditions, are held to be legal and are sustained by the courts. 5 In the case of dividends paid in other forms than cash, the same general rules apply as to cash dividends. There must be an equality among the stockholders, and the proportionate amount, the time of payment, and the form in which the dividend is paid must be the same for all. It may be noted that preferred stockholders share, in relation to holders of common stock, in dividends paid in other forms than cash exactly as they would if the dividends were paid in cash. 6 490. (i) Stock Dividends In some few states stock dividends are prohibited by law. In Massachusetts telegraph, telephone, railroad, and some other classes of public service corporations are forbidden to issue stock or scrip dividends. Even there, however, the end is practically accomplished by the declaration of a dividend to the stockholders. These dividends are then a debt due from the corporation to its stockholders. A simultaneous offering of stock to an equal amount is made and this stock is purchased by the stockholders, their indebtedness therefor being offset by the dividends due them. 7 In most of the states, however, no such restriction exists and stock dividends are not uncommon, and under proper conditions are not legally objectionable. If the directors wish to retain the corporate profits to increase the capital of the corporation, "it becomes immaterial whether such increase is made by award- B Williams v. W. U. Tel. Co., 93 N. Y. 162 (1883); Soehnlein v. Soehnlein, 146 Wis. 330 (1911). Howell v. Chicago, etc., Ry. Co., 51 Barb. (N. Y.) 368 (1868); Gordon v. Richmond, etc., R. R.. 78 Va. 501 (1884). * Jones v. Brown, 171 Mass. 318 (1898); Hyde v. Holmes, 198 Mass. 287 (1908). Ch. 53] DIVIDENDS 435 ing the stock to stockholders as dividends in lieu of money, retaining the money for the purposes of the company, or by paying the stockholders the dividends in cash from the earnings of the company and selling the stock in the market to raise money for the use of the corporation." 8 Or as stated in a later case: So long as every dollar of stock issued by a corporation is rep- resented by a dollar of property, no harm can result to individuals or the public from distributing stock to stockholders. ... All that can be required in any case is that there shall be an actual capital in property representing the amount of share capital issued. 9 A stock dividend issued against actual corporate property of at least equal value is held to be full-paid 10 but, if not so issued in good faith, is not. 11 Where a corporation purchases the stock of another corpora- tion out of its surplus earnings and later distributes such shares of stock among its stockholders as a dividend, such a dividend is not a "stock dividend." 12 It will be observed that a stock dividend of the kind here considered is entirely different from that derived from "stock watering," in which the new stock does not represent profits at all but is merely a dilution of the existing 'capital and is illegal and objectionable. 491. (2) Bond Dividends The corporate bonds may take the place of cash in payment of dividends at the discretion of the directors, provided that they are issued only against actual profits. The argument for their issue is the same as for the issue of stock as dividends. If the company has profits available for dividends, it may take these "Howell v. Chicago, etc., Ry. Co., 51 Barb. (N. Y.) 378 (1868). Williams v. W. U. Tel. Co., 93 N. Y. 162 (1883); Earl J.; Rose v. Barclay, 191 Pa. St. 594 (1899). 10 Kenton, etc., Co. v. McAlpin, 5 Fed. Rep. 737 (1880); Berwind-White Coal Co. v. Ewart, it Misc. (N. Y.) 490 (1895). Shaw v. Gilbert, in Wis. 165 (1901). 11 Gray v. Hemenway, 212 Mass. 239 (1912); Union, etc., Trust Co. v. Taintor, 85 Conn. 452 (1912). 436 CORPORATE LAW [Bk. I- profits for the corporate purposes and replace them with the bonds and distribute these bonds as dividends. The bond dividend is held legal when issued against actually existing corporate profits. 13 From the practical standpoint it must, however, be observed that bonds carry interest which becomes a fixed charge against the company and must be paid thereafter whether profits are made or not. Also the bond itself is an absolute obligation of the company which must be paid at maturity. Both these features may be objectionable, and do not exist in the case of stock. 492. (3) Scrip Dividends The favorite method of paying dividends when neither stock nor bonds are available or expedient, is by means of scrip. This is practically a deferred dividend, scrip being a certificate stating that the owner or holder is entitled to certain rights or privileges specified in the certificate usually a certain amount of cash payable at some fixed future date. In the issue of scrip dividends the same rule obtains as in the case of any other dividends- Profits must exist as a basis for their issue. Usually scrip represents existing profits which are not in the form of money but which may be realized upon at some future date and the money then be used to pay off this scrip. Or there may be no intention that the corporate property shall be realized upon, the expectation being that at the time the scrip becomes due, cash will be on hand for its payment without regard to whether the property in question is sold or not. Sometimes, however, scrip represents an absolute reservation of cash profits, as in a case where the cash is available for divi- dends, but the directors determine that it can be used advan- tageously to improve the corporation.^ plant or equipment. It is generally within the discretion of the directors whether a scrip "Wood v. Lary, 124 N. Y 83 (1891); s. c., 47 Hun 550; N. Y.. etc., R. R. v. Nickals, 119 U. S. 296 (1886). Ch. 53] DIVIDENDS 437 dividend be declared, or whether the earnings be held merely as surplus profits. The effect of the issuance of a scrip dividend is to increase the indebtedness of the corporation by the amount of the dividend. 14 The payment date on scrip may be made absolute, or it may be made contingent, as where it is provided that scrip be payable as soon as the company accumulates sufficient surplus funds for the purpose or when specific property upon which the scrip is based shall be sold, or it may be made "at the pleasure of the Company." In the latter case it has been held that the dividend must be paid within a reasonable time. 15 Scrip is issued in many different forms. Sometimes the certificates are convertible, being exchangeable at a certain time for stock or bonds of the company on demand of the holder. At times scrip certificates entitle the holders to dividends as would stock to the same value. The scrip then partakes much of the nature of stock save that it has no voting power. Scrip certificates, though issued as a dividend and in lieu of certain property in the possession of the corporation, do not fix the ownership of that property in the holders of the certificates. They do give the holder a claim against the corporation not the absolute claim which the ordinary declared dividend gives, but a conditional claim dependent upon the terms of the scrip certificate. Provided only that the principal and any interest to be paid on corporate scrip are "either represented by corporate profits actually on hand or are payable only from future profits, or profits for such payments actually exist at the time or will exist when the demands fall due, the scrip dividend is not illegal. 493. (4) Property Dividends Dividends may consist of actual property, though, except in the case of corporate securities, there are obvious difficulties "Billingham v. Gleason Mfg. Co., 101 App. Div. 476 (1905); affd., 185 N. V. 571 (1906). 14 Billingham v. Gleason Mfg. Co., 101 App. Div. (N. Y.) 476 (1905). 438 CORPORATE LAW [Bk. I- in the way of distribution which make such dividends rare. Thus a company whose profits were in land, might divide this land among its stockholders as a dividend, if it could do so equitably, and no objection could be raised. The more- usual form of property dividends is, however, that of securities of other corporations received, when the corporation sells property or rights of some kind to another corporation, taking the stocks and bonds of that other corporation in payment. Or securities may have been bought outright at some previous time from profits. The stock and bonds so received are then divided among the stockholders of the receiving company as dividends. There are no objections to such dividends provided they repre- sent actual profits. Usually, however, dividends of this kind are declared only when a corporation is liquidated, all its property perhaps having been exchanged for stock or bonds, or both, of the purchasing corporation. In this case the distribution is not, strictly speak- ing, a payment of dividends but is a distribution of assets, and the ordinary rule that dividends may be delared only from profits does not apply, 494. Notice of Dividends The directors of a corporation have full power to fix the time and place of payment of dividends, if reasonable and in good faith, but they must give stockholders due notice. 16 When dividend checks are not mailed, notice must be given the stockholders of the time and place at which dividends will be paid. These notices are sent out by the treasurer or the secretary, according to the regulations of the particular corpora- tion. The officer sending the notices must be governed abso- lutely by the stock book, unless he has personal knowledge or has received formal notice of the fact that some particular stockholder of record is not the stockholder in fact. The party See Book IV, Forms 178-185; also Kingv. Paterson, etc., R. R. Co., 29 N. J. L. 82 (1860). Ch. 53] DIVIDENDS to whom the dividend is to be paid is always the proper party to notify. If there is doubt in any particular case as to whom a dividend is to be paid, responsibility may be avoided by sending notices to all the parties interested, leaving the owner- ship of the dividend to be settled later. In some of the larger corporations, notice of a dividend giving its amount, time and place of payment, and the period for which the stock books are closed, is usually mailed to every stock- holder and is published in the newspapers as well this latter not entirely as a legal requirement but as a general notification to the stockholders and to the general public as well that the cor- poration is paying dividends. The publication of the dividend notice is presumptive proof of notice to the stockholders but is not alone conclusive. If the stockholders see the notice, it is sufficient, but if any particular stockholder does not happen to see the newspaper announcement, he cannot be held to have re- ceived notice and the corporation is liable for any resulting loss. 17 At the present time corporations, when paying dividends, usually mail checks to the stockholders, and this if properly done avoids any possibility of failure of notice. The dividend checks are nothing more than orders upon the bank for payment of the amount due the stockholder, but the recipient of such a check has in the check itself sufficient notice of the time and place for the payment of his dividend. Where checks are mailed, a newspaper notice of dividends -is usually deemed entirely suffi- cient. Dividend notices are frequently signed and issued by the secretary but more commonly are issued over the signature of the treasurer. The legal effect is the same in either case. 495. To Whom Paid A stockholder of record is one whose name appears upon the stock books of the corporation as an owner of its stock. Divi- King v. Paterson, etc., R. R. Co., 29 N. J. L. 82 (1860). 440 CORPORATE LAW [Bk. I- dends are ordinarily payable to those who at the time the divi- dend becomes effective are stockholders of record. The stock book, therefore, at this time shows to whom the dividend must be paid. The rule is not, however, invariable. It may be that stock is pledged and the pledgee has not had the stock transferred to his own name, though dividends are payable to him. Or occasion- ally it happens that stock has been sold before the declaration of the dividend but the transfer, through neglect or other cause, has not been recorded on the books. The equitable ownership of the stock and the right to the dividend then vests in the party to whom the stock has been assigned, but the ownership of record still remains in the former owner. The treasurer, in the absence of notice, has no concern as to these equitable owners. The stock books of the corporation are conclusive for his purposes until their evidence is impeached by the presentation of duly assigned certificates, or other satisfac- tory evidence of a different ownership or by information that would put the corporation "on notice." Therefore, even though it proves later that the holder of record is not the rightful owner of the dividend, the treasurer and the corporation are protected in payments made according to the unimpeached record of the stock books. They have used all reasonable care and cannot be held for the results of negligence on the part of others. 18 If, however, the treasurer or the corporation receives notice of some unrecorded transfer involving the ownership of the dividend, i.e., a transfer made before the dividend became effec- tive or perhaps thereafter with an assignment of the dividend, the treasurer is bound to take notice of the facts and pay the dividend to the rightful owner. 19 As the stock books, if unimpeached, control absolutely, the production of a stockholder's certificate of stock is not necessary, nor can it be required to prove his ownership either of stock or 18 Cleveland, etc., R. R. v. Robbins, 35 O. St. 483 (1880). 19 Rose v. Barclay, 191 Pa. St. 594 (1899). Ch. 53] DIVIDENDS 441 of dividends if this ownership is shown by the stock books. li the true ownership is not so shown, the duly assigned certificate is good evidence thereof and sufficient to justify the treasurer in paying the dividend to the owner of the certificate, provided only that the assignment was made before the effective date of the dividend. If there is any real doubt as to whom a dividend is properly payable, the treasurer's only safe course is to withhold payment until the matter is satisfactorily settled by the parties them- selves, or until the ownership of the dividend is determined by proper legal procedure. This litigation may involve only the disputants but may be directed also against the corporation. If in any case the corporation is likely to suffer, it may interplead and ask the court to decide to whom the dividend belongs. In case stock stands in the name of a married woman, the treasurer must pay the dividends declared thereon to the wife, unless the husband is empowered as her agent to receive it. If stock is pledged, the pledgee is entitled to any dividends declared meanwhile even though he is not a stockholder of record, provided the corporation has had due notice of the pledge. But the pledgee must account for these dividends to the pledger when the pledge is redeemed. 20 If a corporation holds stock of other corporations, it is entitled to receive dividends on this stock as is any other stock- holder. It cannot, however, pay dividends on its own stock held in the treasury of the corporation. When dividends are payable to a corporation the dividend check may be made either in the name of the corporation, or to the treasurer as treasurer of the corporation. If stock belongs to an estate, payment of dividends should be made to the administrator. If, however, the stock passes to a legatee, all dividends declared after the date of the testator's death belong to the legatee, but if any dividends have been declared before that date but are not yet paid, they will belong to the general estate. i Cook on Corps., f 468. 442 CORPORATE LAW [Bk. I- 496. Payment of Dividends It is customary to close the stock books a certain number of days before a dividend is to be paid, in order to give the treasurer an undisturbed opportunity to make up his dividend statement from the books. The "closed" period usually continues until the date of its payment, or, if this period is lengthy, for such reasonable time as will enable the treasurer to secure from the books the data he requires for his dividend statement. During this period no transfers of stock will be made. As a rule the closing of the transfer books works no hardship. They are not usually closed until the day on which the dividend is effective. Transfers of stock made after that -date do not, therefore, carry the dividend, unless by special agreement between the parties, and the fact that the transfer cannot be immediately recorded is in most cases immaterial. If transfers prior to the declaration of the dividend have not been recorded, they are of course shut out, and, to secure the dividend which rightfully belongs to such unrecorded stockholders, they must take up the matter with the transferrer and secure from him an order on the treasurer. 497. Dividend Checks As soon as the stock books are closed, the treasurer is fur- nished by the secretary with a list of the stockholders of record as they appear on the date of closing, or otherwise the stock books are turned over to him and he secures the names and the addresses of the stockholders himself. The treasurer then makes up his dividend statement, showing the amount of stock held by each stockholder and the amount of dividends due him. The checks for dividends are made out and on the appointed date are mailed to the parties to whom they are due, or if dividend checks are not mailed, the stockholders are notified to call and receive their dividends in person. In the smaller corporations the dividend check is usually nothing more than the ordinary check of the corporation, either Ch. 53] DIVIDENDS 443 marked or stamped "Dividend Check," or accompanied by a brief notice stating that the check is in payment of the specified dividend. In the larger corporations special checks are usually printed, with the words "Dividend Check" or "Dividend No "or some other identifying phrase appearing on the face of the check. Where the stockholders call in person for dividends, they are usually required to sign the regular receipt form upon the dividend book. If the checks are mailed, receipt forms are sometimes sent with them, to be signed and returned by the stockholders. Usually and preferably, however, the check itself is deemed an all-sufficient receipt. When stamped "Divi- dend No " or with some equivalent identifying phrase, as is usually the case, and indorsed by the recipient, as must be done before the check can be collected, and stamped or can- celed by the drawee bank when paid, the check itself undoubtedly does afford the best possible evidence of the payment of the dividend. The check is usually accompanied by a notice that a receipt either is or is not required, as the case may be. The dividend check is in no wise different in its nature from any other corporate check. It should be deposited or otherwise presented for payment promptly, and if this is not done, the recipient must bear any loss due to such delay in presentation. The dividend check is also subject to all the usual customs and requirements relating to checks. 498. Illegal Dividends The declaration of an illegal dividend or the payment of an illegal dividend already declared may be enjoined and stopped by proper action of the stockholders. Illegal dividends may be of three characters: 1. Those declared in disregard of the rights of some of the stockholders. 2. Those declared in violation of charter or by-law pro- visions of the particular corporation. 444 CORPORATE LAW [Bk. 1- 3. Those which either impair the capital stock or threaten the solvency of the corporation. 1. Dividends which are unequal among stockholders of the same class are absolutely in disregard of the rights of the stock- holders discriminated against so much so, that cases directly involving the principle but seldom arise. When inequalities are attempted it is usually by means of diversions of the profits, such as payments of excessive salaries or unnecessary expenditures. Another instance of dividends in disregard of the rights of stockholders is sometimes found when the directors declare dividends on common stock while cumulative dividends due on preferred stock have not been paid. In such a case the court will compel a readjustment of the dividends. 21 2. Dividends declared in violation of charter or by-law pro- visions may be perfectly proper in themselves but illegal merely because of their prohibition. Thus, the charter or by-laws may provide that no dividend shall be declared until after surplus funds have been accumulated to some specified amount. Then if dividends are declared before this surplus has been reserved, they are illegal and payment may be enjoined by proper action of the stockholders. 3. The most common form of illegal dividends is that which impairs the capital stock or which endangers the solvency of the corporation. In a case of this kind it is to some extent a matter of bookkeeping and judgment as to whether a dividend is such as to impair the capital stock or render the company insolvent. If the directors declare a dividend in good faith, after a proper investigation of the financial condition of the company, the courts are not likely to interfere. A case of illegal dividends comes within the jurisdiction of courts of equity, and any stockholder may bring suit therein to enjoin the declaration of a dividend believed by him to be illegal. An illegal dividend may be rescinded by the directors at any tune before its payment. 21 Luling v. Atl. Mut. Ins. Co., 45 Barb. (N. Y.) 510 (1865). Ch. 53] DIVIDENDS 445 499. Liability for Illegal Dividends In most of the states a liability is imposed upon the directors by statute for any violation of the laws regulating dividends. In some cases offending directors are made liable for any and all debts of the corporation incurred during their term of office. In other cases they are liable only for the amount actually paid out in these illegal dividends. In some states they are not only held liable for the corporate debts, or for restitution in case of dividends illegally declared, but are also guilty of a misde- meanor punishable by fine and imprisonment. If the directors of a corporation declare a dividend in violation of its charter or by-law provisions, they may be enjoined from its payment, or if not, would undoubtedly be held liable for any damage to the corporation which may result from the illegal dividend. When dividends are declared which impair the capital stock or render the corporation insolvent, they not only subject the directors to liabilities and in some cases penalties, but such illegal dividends may be recovered from the stockholders to whom they were paid. It is the well determined doctrine of the courts of this country that the capital stock is a fund to be preserved for the benefit of corporate creditors. Hence the rule has been firmly established that where dividends are paid in whole or in part out of the capital stock, corporate creditors being such when the dividend was declared or becoming such at any subsequent time, may to the extent of their claims, if such claims are not otherwise paid, compel the shareholders to whom the dividend has been paid to refund whatever portion of the dividend was taken out of the capital stock." If a dividend has been paid out of the capital stock, the stock- holders are conclusively presumed to have known it and are liable to an action for repayment. They cannot claim to hold the position of innocent or bona fide holders. 2 Cook on Corps., 5 548. 446 CORPORATE LAW [Bk. I- As already said, in some few states the officers are, together with the directors, liable for dividends paid in violation of statutory provisions. As a rule, however, the treasurer is not personally liable in any way for the payment of dividends ordered by the directors unless he knows such dividends to be absolutely fraudulent. In a few states, however, liability for dividends prohibited by statute has been extended by express enactment to the executive officers of the corporation if they consent or concur therein. In such states, if the treasurer, knowing the dividends to be in violation of the statutory pro- vision, nevertheless obeys the instructions of the directors and either pays such dividends or permits them to be paid, he is liable with the directors. There are, it may be said, but few states in which this liability exists. The treasurer usually furnishes to the directors the statement of the corporate accounts and finances which determines whether or not dividends shall be declared. It is his duty to provide an accurate statement, and should his presentment be so erroneous or so carelessly compiled as to mislead the directors and cause the declaration and payment of improper dividends, he would have failed in the "due diligence" and reasonable care exacted of the treasurer as an agent of the corporation and would be liable for any resulting loss. Beyond this the treasurer is also responsible for the proper payment of dividends, not only as to the actual computation of amounts due and the proper drawing of the dividend checks, but for their delivery to the proper persons. CHAPTER LIV 500. Nature of a Bond When a corporation borrows money, its indebtedness may be evidenced by either notes or bonds. If the amount bor- rowed is small, or if it is borrowed in a single sum, or from but few persons, or for a short time, notes are usually given. If, however, the amount is large and obtained from a number of people and extends over a period of years, the corporate obliga- tion is preferably and usually evidenced by bonds. The difference between a corporate note and a bond is not always clearly marked. Both are promises to pay money. The phrasing of the bond is usually more formal than that of the note. Also it must be executed under seal, while the corporate note need not. Also payment of bonds is usually, though not invariably, secured as to both principal and interest by certain specified property held for the purpose under a formal deed of trust. A bond payable to order, -or bearer, or holder is a negotiable instrument, and this in spite of the fact that it is executed under seal. Hence, if such a bond is in due form and is purchased for value and in good faith, the purchaser is protected against any defenses set up by the corporation and against any claims of previous owners. A bond issue consists of a number of bonds which, while they may vary as to denomination, and some may be registered and some unregistered, are all of like general tenor, and if secured are all secured, and, unless otherwise expressly provided, equally secured, under one deed of trust. See Book II, Part II, "Corporate Securities"; also Book III, Part IV,"Bonds and Funds." 447 448 CORPORATE LAW [Bk. I- Bonds are issued in varying denominations but those of the larger corporations are usually of $1,000 denomination and issued in coupon form. Bonds of the face value of $500 are not infrequently issued and $100 bonds are seen occasionally. Coupon bonds usually have a space for the recording by the company of the name of the bond owner when the latter so desires, the company or its fiscal agents keeping a record of all such registrations. Such bonds are termed "registered as to principal only," and until registered "to bearer," negotiability by delivery ceases. The interest instalments on such bonds continue to be represented by coupons which are payable to bearer. Coupon bonds can usually be exchanged for "fully regis- tered bonds" without coupons, these usually being issued in denominations of $1,000, $5,000, $10,000, and even larger. The interest on fully registered bonds is paid by check, as in the case of dividends on stocks, to the holder of record. The advantage of the unregistered coupon bond is found in the readiness with which it may be transferred. The advantage of a registered bond, whether coupon or otherwise, lies in the difficulty of its negotiation in case the bond is lost or stolen. If a bond payable to bearer is either lost or stolen, its sale or disposal is comparatively easy and, once in the hands of an innocent holder for value, the stolen bond is valid. A registered bond, on the contrary, should it be lost or stolen, is practically non-negotiable. It is payable only to the party named in the bond, and a successful negotiation of the bond involves a forgery of his signature which would prevent a valid transfer. When registered bonds are assigned, the assignee usually surrenders the old bond and receives in exchange a bond issued in his own name, the new ownership being recorded upon the books of the company at the same time. Bonds are a direct corporate obligation and do not in any way partake of the nature of stock. They may, however, be given rights of participation in corporate profits if desired, Ch. 54] BONDS 449 and, in the absence of statutory prohibition, may be given vot- ing rights as well. But even though this last privilege is extended, it is rarely exercised if the bonds are in coupon form and widely scattered. 501. Authorization of Bond Issues "The power of a corporation to borrow money is implied and exists without being expressly granted by charter or stat- utes." 2 In the absence of restraining laws, a corporation may therefore issue corporate notes and bonds to any desired amount. In most states, however, constitutional or statutory provi- sions are found directly limiting or otherwise affecting the com- mon law right of corporations to borrow money or incur debt, particularly by the issue of bonds, and in many states statutes prohibit the directors from issuing bonds until authorized thereto by the stockholders. Constitutional provisions affecting the issue of bonds are found in many states but as a rule confine themselves to the requirement that bonds shall be issued for value only and that any fictitious increase of indebtedness is void. Statutory provisions limiting the amount of corporate in- debtedness are found in many states. Thus in Florida, Ken- tucky, Minnesota, and some other states, the maximum cor- porate indebtedness that may be incurred must be stated in the charter. In Illinois and in some other states, the total aggre- gate of the corporate indebtedness must not exceed the total amount of the capital stock. In other states, as Nebraska and Vermont, the corporate indebtedness must not exceed two-thirds of the capital stock. In New Hampshire it may not exceed one- half the value of the company assets. Provisions requiring the assent of a specified majority of the stockholders before bonds may be issued are also found in many states. Thus in California, Nevada, New York, and other 3 Cook on Corps., i 760. 450 CORPORATE LAW [Bk. I- states, a bond issue must be authorized by a two-thirds vote of the stockholders. In Alabama, Missouri, Pennsylvania, and a number of other states, it may be authorized by a mere ma- jority of the voting stock. In Ohio a three-fourths vote of the stockholders is required before convertible bonds may be issued. The statutory provisions also frequently specify the notice which must be given for stockholders' meetings to authorize bond issues. In some states specific provisions exist as to the selling price of bonds, as in North Carolina where the statutes provide that bonds may be sold below par and commissions may be paid upon the sale, or in Wisconsin where the true value of the money, labor, or property received for bonds must be at least 75% of their par value. The Wisconsin provision, it must be added, is further weakened by the enactment that, notwith- standing its terms, bonds may be sold at the best price obtain- able on the stock exchanges of Chicago, New York, Boston, or Philadelphia. Special provisions as to bond issues are found in some states, as in Louisiana, New Mexico, Nevada, Missouri, New Jersey, and Ohio, where the statutes expressly authorize the issue under proper procedure of bonds convertible into stock; or in Delaware, where bondholders may be given the same rights as stockholders; or in Nevada and Virginia, where by proper procedure bondholders may be given the right to vote. It may be noted that the Illinois courts hold that bondholders cannot be given the right to vote at corporate meetings. 502. Secured and Unsecured Bonds 8 The payment of corporate bonds may be either secured or unsecured. If unsecured, the bonds are usually termed "de- bentures." The usual unsecured debenture bond is merely the formal corporate promise to pay money. It is an obligation of the See Book II, Ch. VIII, "Secured Bonds," and Ch. IX, "Unsecured Bonds." Ch. 54] BONDS 451 corporation, but as it is unsecured there can be no foreclosure in case of default on either interest or principal. In such case the holder has no remedy except the ordinary suit at law on an unpaid note. It is merely an unsecured debt of the corporation and has no precedence over any other unsecured debt. Its claim is superior to that of preferred stock, but is inferior to that of any secured indebtedness of the corporation. Its value depends entirely upon the solvency of the issuing corporation. A mortgage bond is one the payment of which is secured by a mortgage or deed of trust on part or all of the property of the corporation. This deed of trust usually authorizes the trustees, in case of default on interest or principal of the secured bonds, to take possession of the property and either operate it or sell it, as may be provided, for the benefit of the bondholders. "Mortgage" bonds are in effect first mortgage, second mort- gage, etc., according to the lien of the deed of trust by which they are secured. But unfortunately a so-called first mortgage bond is not always what its name implies, as it may be preceded by a prior lien mortgage securing bonds senior in lien to those issued under the so-called first mortgage. A notable instance of this is the Toledo, St. Louis and Western $6,500,000 of First Gold 4's, which are actually junior in lien to $9,575,000 Prior Lien Gold 3^2 's; in other words, there is a prior lien before the first mortgage. A second mortgage bond secured on the same property as that already covered by one mortgage is a second lien, i.e., in case of foreclosure the first mortgage bonds must be paid in full, both principal and interest, before the holders of the second mortgage bonds receive anything. Hence, real first mortgage bonds are more desirable than those of a junior lien, i.e., those of an inferior or later lien, unless the property is of such value as to be an absolute and unquestionable security for the entire amount of outstanding bonds; but a bondholder must ascertain that the so-called first mortgage bond is actually a first mortgage or first lien, and not such in name only. 452 CORPORATE LAW [Bk. I- 503. Coupon Bonds A coupon bond is one to which coupons are attached, each coupon requiring payment on its due date of the interest instal- ment represented by that particular coupon. Such coupons are in effect promissory notes, each calling for the payment of one instalment of interest on a bond. The interest on coupon bonds is payable to the holders of these coupons and not to the holder or owner of the bonds unless he is also the holder of the coupon. 4 Interest on bonds is usually payable semiannually, and each of the coupons attached to a coupon bond calls for the exact amount of one of the semiannual interest payments on that bond. Thus a bond running ten years with interest payable semiannually would have attached to it twenty coupons. Each coupon is numbered to correspond with its bond but also has a serial number running from one to twenty in the instance cited indicating the order in which the coupons come due. A coupon is in form a promissory note. It is attached to the bond as a convenient method of indicating the amount and the due date of interest and for its collection when due. One coupon is attached to the bond for each interest instalment. Thus a 2o-year bond with semiannual interest payments would carry forty coupons. These coupons are numbered serially and also carry the number of the bond to which they are attached. Coupon No. i represents the interest that will be due at the first interest period. As soon as that period arrives the coupon matures, and it is then detached from the bond and either pre- sented for payment or deposited for collection as would be done with any other promissory note. When an interest payment on coupon bonds is about to fall due, the amount necessary to meet the maturing coupons is usually deposited in some designated bank which acts for the corporation and pays the coupons as they are presented. The coupons are then canceled and are pasted in the coupon register. See Book IV. Form 2so. Ch. 54] BONDS 453 504. Deed of Trust Usually a statement of the general conditions of a bond issue appears upon the face of each bond and reference is made to any features of special importance, such as the existence of a sinking fund, the conditions of redemption, the method of transfer and exchange when bonds payable to bearer and regis- tered bonds are issued under the same deed of trust, etc. The language of a bond is usually more formal than that of a note, it must be executed under seal, and, if secured, refer- ence is made in the bond itself to the deed of trust under which it is issued. Bonds issued under a deed of trust must usually be certified by the trustee before they are issued. The trustee's certificate appears on the back of each bond, and evidences the fact that the bond is one of the issue mentioned in the deed of trust. 5 As a rule, the object of this certificate is merely to identify the bond and to prevent overissues. If the trustee certifies more bonds than are called for by the deed of trust, he may make himself personally responsible for the overissue, but otherwise he incurs no liability whatsoever by reason of his certification. A certification is not part of the bond, though it may be required before the bond itself can be considered as issued, nor is it in any sense an indorsement of the bond nor a certification of its correctness as to form or subject matter. A deed of trust is a mortgage on certain specified property given to a trustee who acts for the holders of the bonds secured thereby. The deed of trust recites at length the terms and con- ditions under which the bonds are issued and under which the property for their security is held. 6 A modern deed of trust is usually a very comprehensive and formidable instrument. A brief form may occupy perhaps from 10 to 20 pages of printed matter. More extended forms fre- quently occupy 100 pages or more. * See Book IV, Form 251. See Book IV, Form 253. 454 CORPORATE LAW [Bk. I- In the bond itself reference is always made to the deed of trust by which it is secured, and in the deed of trust the bond is recited in full. The bond by express terms is subjected to the conditions of the deed of trust. Accordingly the statements of the bond are controlled by the explanations and any non- conflicting conditions of the deed of trust. If, however, the terms of the bond and of the deed of trust conflict, the bond prevails. 7 If the deed of trust fails for any reason, the bonds then become the unsecured obligation of the corporation and take their place on a parity with the other unsecured corporate debts. 505. Recitals of Deed of Trust In the deed of trust usually employed the preamble recites the conditions precedent to the issue, the form of bond in full, and the form of coupon and trustee's Certificate, also in full; followed by the granting clauses, including description of prop- erty covered, and by the trust reservation with stipulation for equal participation of all the bonds of that issue in the protection afforded by the mortgaged property. Following this come the "covenants, conditions, uses, and trusts" subject to which the bonds are issued and the mortgaged property is held. These have a wide range. Some of the more usual are as follows: 1. Procedure for execution, certification, and delivery of bonds. 2. Enjoyment of property by mortgagor until default in payment. 3. Payment of principal and interest without deduction for taxes, and in "gold coin," "legal tender," or otherwise, as the case may be. 4. Payment of all taxes and assessments on property held under the deed of trust and, if the nature of the property is such as to require it, maintenance of the same in repair, under due insurance and free from liens. i Railway Co. v. Sprague, 103 U. S. 756 (1880). Ch. 54] BONDS 455 5. Provision for any necessary additional assurances for protection of bondholders. 6. Provision for trustee to enter upon property and conduct business without foreclosure under certain conditions. 7. Sinking fund for retirement of bonds. 8. Procedure for foreclosure in case of default. 9. Provision that bonds shall be matured by failure to pay interest. 10. Stipulation that loans, advances, or payments made on coupons for account of the mortgagee shall not keep such coupons alive. 1 1 . Provision for redemption of bonds. 12. Provision for discharge of deed of trust. 13. Provision for substitution or appointment of new trustee. 14. Disclaimer of responsibility on part of trustee. 15. Interpretation of terms used in deed of trust. 1 6. Provision that deed of trust may be executed in duplicate parts. In addition to these common provisions, others are often dictated by particular conditions. Thus, if both registered and coupon bonds are issued, provision must be made for registra- tion and for the exchange of one for the other if this is prescribed; also provisions may be inserted for the issue of temporary cer- tificates, or for replacement of destroyed or mutilated bonds, or for discrimination against coupons detached or assigned before maturity, or for exemption of the stockholders and officers of the issuing company from all liability under the deed of trust or for the bonds issued thereunder; or in a mortgage on realty it may be provided that upon payment to the trustee of a certain specified price, parts of the property may be sold free from the encumbrance of the mortgage, or that under prescribed condi- tions properties may be withdrawn from the mortgage and new properties substituted in their place. The duties of the trustee under a deed of trust are usually few but may be onerous. He certifies each bond issued. At 456 CORPORATE LAW [Bk. I- times the recording of the deed of trust is made one of his duties. In case of default he is usually required either to take possession of the property and operate it or sell it, according to the condi- tions of the deed of trust, for the benefit of the bondholders. If called upon to operate the property, his duties and liabilities may be heavy. 506. Execution and Filing of Deed of Trust The deed of trust is executed with the same formality as a deed of land. It must be signed and sealed both by the cor- poration and by the trustee, and be duly acknowledged before a notary public or other duly authorized officer. The corporate signature is usually affixed by the president, and the corporate seal is affixed and attested by the secretary. The acknowledg- ment is also usually made by the president of the corporation, but is of equal force if made by the secretary, treasurer, or any other duly authorized executive officer. It is immaterial whether the deed of trust be executed within the state in which the cor- poration was organized or elsewhere. If realty is included, the deed of trust must be filed in the office of the county clerk in every county in which the real estate is situated. CHAPTER LV BONDS (CONTINUED) 507. Sinking Fund l A sinking fund as applied to bond issues is a fund created for the purpose of redeeming the bonds when due, or prior thereto, as may be provided by the deed of trust. Thus bonds may be retired from time to time as the sinking fund accumulates, or the fund may be allowed to remain intact until the maturity of the bonds, when, if properly constituted and maintained, it is sufficient for the retirement of the issue. Sinking fund requirements will vary with the conditions. Sometimes a stated annual amount is paid into the fund. At other times the income from a certain source will be devoted to this purpose. Coal mining companies frequently reserve a certain amount for each ton of coal mined. Lumber companies sometimes reserve a certain amount on each thousand feet of lumber cut. In the smaller corporations the sinking fund is usually infor- mal and is kept in the custody of the corporation. For the larger bond issues, a sinking fund is usually established in the hands of a special trustee, subject to the conditions of the deed of trust. The wisdom of a sinking fund is, in the case of most bond issues, apparent. Reserving as it does a moderate amount each year for the payment of the bonds, their final redemption is effected with comparative ease. Without such a fund another bond issue to retire the maturing bonds, or a default, would be the probable result. In the case of .railroads there is a tendency to dispense with > See also Book II, Ch. XI, "Redemption of Bonds Sinking Funds"; also Book III. Ch. XXII, "Prind'ples of Fund Accounting. " 457 458 CORPORATE LAW [Bk. I- sinking funds when bonds are issued for permanent additions or improvements, the bonds when due being replaced by a second issue. This is based upon the principle that the additions or improvements being permanent and being maintained out of earnings, are as much for the benefit of subsequent as of present stockholders and that the present stockholders should not be deprived of their dividends merely to provide a more valuable property and larger dividends for those who come after. Or it may be considered that the bonds are a permanent portion of the' capitalization on which interest is paid instead of dividends. 508. Sale of Bonds Unless prevented by statutory enactment, bonds may be sold at any price that can be obtained. In most of the states there are provisions that bonds may be issued only for value actually received, but in the absence of some more specific limitation, bonds may still be issued below par if in good faith. In some few states more specific provisions exist. The sale of bonds below par by the issuing corporation may, however, constitute an infraction of the laws against usury. Thus, if a 5% bond of the face value of $1,000 be sold for $500, the rate of interest paid on the money so secured is 10%. If, then, this exceeds the legal rate of interest in the state in which the sale was made, the transaction is usurious and illegal, and for this reason the original purchaser, or subsequent purchaser knowing the conditions, might be unable to enforce the payment of his bond. This could not, however, be the case if the bonds were in the hands of an innocent holder for value, nor in states in which the statutes are silent as to usury, nor in states where bonds may by statute provision be sold below par, nor in states where corporations are not allowed the defense of usury. 509. Vendors and Holders The vendor of a bond does not warrant the legality of the issue nor in any way guarantee payment of the bond. All he Ch. 55] BONDS 459 undertakes is that so far as he has knowledge the bond is legally issued and is what it purports to be, that it has come into his hands in due course and for valuable consideration, and that he is legally competent to transfer it to the purchaser. In this the bond differs from a note, draft, or check, which the vendor is held to guarantee unless assigned "without recourse." A bond as a negotiable or quasi-negotiable instrument is not subject to the defenses that might exist between the original parties. In practice, "the courts go very far in protecting bona fide holders of corporation bonds, and will uphold "and enforce such bonds under nearly all circumstances. The defense that the bond was issued below par does not avail as against a bona fide holder." 2 A first mortgage bond does not lose its priority though issued after a second mortgage bond. Nor does the number or date of issue of a bond in any way affect its rights of payment as regards the other bonds of the same issue, unless expressly so provided by the bond or the deed of trust. Such provisions are legal but unusual, and as a rule every bond of an issue has all the rights of any other bond of that issue. Bonds cannot be paid by the issuing corporation before they are due save by consent of the holders, unless there is express provision in the deed of trust for such prior redemption, but this does not preclude their purchase in the open market prior to maturity by the debtor corporation. If at the maturity of the bonds all are not presented for payment, the trustee may reserve a sufficient amount of money for the retirement of the missing bonds and discharge the deed of trust. Suit may be brought on a bond or coupon if not paid at maturity, just as suit may be brought on a promissory note, and this even though the mortgage is not foreclosed. In case of judgment, however, no execution may be had against the mort- gaged property. In some few states, as in New Jersey, such 1 i Cook on Corps., | 766; also Dickermann v. Northern Trust Co., 176 U. S. 188 (1900). 460 CORPORATE LAW [Bk. I- suit by the individual holders before foreclosure is forbidden by statute. In case of foreclosure, if the property held under the deed of trust is not sufficient to pay the bonds secured thereby, the bondholders have recourse against the corporation for the balance due. 510. Redemption of Bonds 3 The date of maturity of bonds is stated in the deed of trust and also on the face of each bond. The deed of trust also usually provides that if any instalment of interest is not paid when due and the default continues for some specified length of time, the principal of the bond is thereby matured and must be paid. In event of default either on principal or interest, it is usually provided that foreclosure may follow, or perhaps, preliminary thereto or in lieu thereof, the trustee is authorized to take possession of the mortgaged property and operate it for the benefit of the bondholders. When bonds are redeemed in accordance with the terms of the deed of trust, they are canceled and cannot be reissued unless expressly so provided in the deed of trust. A corporation might, however, purchase its bonds in the open market and sell them again later. In some cases provision is made in the deed of trust for redemption of bonds prior to the maturing date. Also, con- vertible bonds are at times issued which, if the holder elects, may be redeemed in stock of the corporation. Also at times it is provided that as the sinking fund accumulates, the funds may be used from tune to time to redeem the outstanding bonds. 511. Investment Value of Bonds If bonds are purchased at par, the return on the investment is the exact interest paid on the bond. If, however, bonds are See also Book II, Ch. XI, "Redemption of Bonds Sinking Funds"; also Book III, Ch. XXIV, "Redemption of Bonds." Ch. 55] BONDS 461 purchased either above or below par, the determination of the actual return on the money invested becomes somewhat difficult. Thus, if a $1,000 bond due in 10 years and bearing interest at the rate of 5%, is purchased at $900, it is obvious that the direct interest on the investment is considerably in excess of 5%, amounting to 5 5/9%. In addition to this, when the bond is paid at maturity, its full face value.of $1,000 is received, giving a further return or profit of $100 on the original investment. On the other hand, if the bond is purchased at a premium, say at $1,100, the direct interest returns are but 4 6/11%, and on maturity of the bond the purchaser receives but $1,000, which is $100 less than the price he paid for his bond. There is therefore a double loss both on interest and principal. A rough approximation of the returns on the investment when bonds are purchased at a discount or at a premium, may easily be made, but if exact results are to be reached which are required when large investments are to be made the calcula- tions are laborious. For use in such cases bond tables may be purchased from which the actual investment value of any ordinary bond, whether sold at a discount or at a premium, may be found at any period of its life, 512. Kinds of Bonds Many classes of bonds are issued under varying designations, usually derived from the more important or distinctive features of the particular issue. The bonds most frequently issued are briefly discussed in the present section. 4 Bonds frequently possess the characteristics of several dif- ferent classes. Thus, the bonds of the United States Steel Corporation, known as "ten-sixty-year five per cent sinking fund gold bonds," are redeemable at any time after ten years from date of issue at 110% of their face value. Their payment is provided for by a sinking fund, and they are payable in gold coin. Also, if not previously redeemed, they must be paid at See also Book II. Ch. VII-X. 462 CORPORATE LAW [Bk. I- the end of 60 years and bear 5% annual interest. All this is indicated by the name. 1. FIRST MORTGAGE, ETC., BONDS. A real first mortgage or prior lien bond is one secured on property upon which no other bonds or similar obligations are secured. Usually a first mort- gage bond is a first lien on the property by which it is secured, though this is not invariably the case, as for instance, a builder's lien upon property covered by the deed of trust takes precedence over the bonds. A number of bonds may be secured by the same property. In such case the first issue is, as stated, a first mortgage bond or prior lien; the next a second mortgage bond; the next a third mortgage bond, etc.; the lien of each of these latter being inferior to that of the bond or bonds which precede it, but su- perior to that of the bond or bonds which follow. As a matter of practice, however, bonds are rarely issued under the term of second mortgage, third mortgage, etc. A more euphemistic term is usually chosen, as general mortgage, refunding mortgage, consolidated mortgage, etc. The par- ticular description used has no significance, as in some cases a general mortgage precedes a refunding mortgage and in other cases the reverse is true. 2. JUNIOR LIEN, ETC., BONDS. A junior lien bond is one which comes after or is inferior to some other bond or bonds in its lien upon the property by which it is secured. Thus the lien of a second mortgage bond is a junior lien to that of the first mortgage bond. When several different issues of bonds are secured by the same property, those having the superior lien are sometimes styled underlying bonds, the term indicating that they are closer to the property and have a superior claim. Thus, if first and second mortgage bonds are secured ori the same prop- erty, the first mortgage bonds are underlying bonds. If third mortgage bonds are also issued, both first and second mortgage bonds are underlying bonds. Ch. 55] BONDS 463 3. GOLD, ETC., BONDS. A bond may in express terms provide for payment in gold, silver, legal tender money, etc. Such provisions are legal and enforceable. If no medium is specified in which payment of a bond must be made, legal tender is always understood. 4. CONVERTIBLE BONDS. A convertible bond is one which under prescribed conditions carries the right of conversion into other securities of the same corporation. The usual form of convertible bond is that which may be exchanged for common or preferred stock of the issuing corporation at a fixed rate of exchange and within a certain period. It is obvious that the conversion privilege gives a bond a speculative character which adds greatly to its attractiveness as an investment. If the stock of the issuing company advances materially, the exchange can be made at a profit. If the stock does not advance, the bonds themselves are still a good invest- ment. In short, the plan combines the safety of a bond invest- ment with the profit possibilities of an investment in stock; but it must be borne in mind that the conversion privilege is usually given to a junior lien bond, the conversion privilege being in- tended to offset, in part at least, the bond's inferior lien. 5. INCOME BONDS. Income bonds to which some prefix is frequently added usually come into existence as a result of a reorganization where holders of bonds bearing a fixed rate of interest accept in exchange a bond whose interest is contingent on earnings. Income bonds vary in their nature materially. Usually they are an absolute junior mortgage on the property, but rarely a first lien, and occasionally they are mere deben- tures. Some carry cumulative interest, others do not. The security of the latter is precarious unless secured by an instru- ment that clearly defines just what is to be construed as net income applicable to interest payment. In general, the use of such bonds is unfortunate and the credit of the issuing company lower than if preferred stock were used. As a rule income bonds carry no voting power and the bond- 464 CORPORATE LAW [Bk. T. - holders having acquired their security in exchange for an interest- bearing bond feel themselves in the position of creditors eager for their interest regardless of the advisability of payment from the company's standpoint, and the latter is equally eager to delay payment of interest until the general finances of the com- pany are in good shape. Not infrequently the whole matter ends in court if the bondholders can find legal ground upon which to bring an action. The use of preferred stock would be better for all concerned, but bondholders will accept an income bond in a reorganization where they refuse preferred stock, hence the use of the bond. v 6. COLLATERAL TRUST BONDS. A collateral trust bond is one which is secured by collateral usually stocks and bonds of other corporations owned by the issuing corporation. These are deposited with a trustee under an agreement setting forth the conditions of the trust. The bond is then in effect a collat- eral note and is frequently termed a "collateral trust bond." 7. GUARANTEED BONDS. A guaranteed bond is one the payment of which, either as to interest or principal or both, has been guaranteed by some other corporation. Such a guarantee must be in writing and must either be written on the instrument itself or be attached to it to be effective. Under proper conditions such guaranteed bonds are legal and are frequently issued. Thus the bonds of a subsidiary road may be guaranteed by the parent road, or a bond of a compo- nent corporation may be guaranteed by the holding company or trust of which it forms a part. Guarantees are of doubtful value in most cases, and when trouble comes upon a company, the bondholders usually have to look to their real security rather than the guarantor. 8. TERMINAL, ETC., BONDS. Terminal bonds are those issued by and secured on the property of a terminal company which is usually subsidiary to the railroad or steamship line using the terminal. Such bonds are usually issued for terminal pur- chases or improvements. Extension bonds are those issued by Ch. 55] BONDS 465 a railroad to extend its lines. Equipment bonds are those issued for equipment, usually by a railroad company, though they might be issued in connection with an industrial corporation. Con- struction bonds, as their name indicates, are those issued to secure money for the purposes of construction. 9. CAR TRUST BONDS. Car trust or equipment trust bonds or certificates are issued by a trustee who holds for their security equipment purchased or leased by a railroad company. The money realized from the sale of these bonds goes to the manu- facturers or vendors of the equipment, or the bonds may be turned over to them direct. The railroad company receives its equipment, subject to the trust agreement, and retires the equipment bonds in such amounts and at such periods as are fixed by the trust agreement. The title to the equipment does not usually vest in the railroad company until all the bonds are redeemed. Bonds and notes of this character are usually issued in series and are redeemable in their serial order as payments are made by the railroad company. When the final payment is made by the railroad company, the deed of trust by which the property is held is released and the equipment becomes the property of the purchasing company. 10. PURCHASE MONEY BONDS. Purchase money bonds are those given to secure money for the purchase of the property by which they are secured. 513. Short-Term Notes A short-term note is merely a corporation's promissory note. It may be secured or unsecured. If secured, it is usually by the deposit of collateral with a trustee under a trust agreement. The larger issues are generally in coupon form and differ but little from the usual bond, except in their early maturity. Short-term notes are issued when the existing conditions are unfavorable for a long-time loan, and usually carry either a larger rate of interest than a bond issue or are sold at a discount 466 CORPORATE LAW [Bk. I- that produces the same practical result. Short-term notes are usually floated with the expectation that they will either be retired at maturity or will be taken up by a bond issue on more favorable terms than would have been possible at the time the notes were issued. Part XII Corporate Arrangements CHAPTER LVI >v VOTING TRUSTS 514. General It is frequently necessary or important that the agreed management of a corporation be preserved consecutively for a term of years. This may be for the protection of minority or special interests, or to maintain a control satisfactory to the majority as then existing, or in pursuance of organization agree- ments, or in accordance with the terms of a reorganization or consolidation. In any such case the voting trust sometimes called a "stock pool" is the usual means by which this is secured. Shareholders have the right to combine their interests and voting powers to secure such control of the corporation and the adoption of and adhesion by it to a specific policy and course of business. Agreements upon a sufficient consideration between them, of such intendment and effect, are valid and binding, if they do not contravene any express charter or statutory provision, or contemplate any fraud, oppression or wrong against the other stockholders or other illegal object. 1 The voting trust is an arrangement under which sufficient stock to insure the desired ends is placed in the hands of trustees for some certain period of time, with definite instructions as to the way in which this stock shall be voted. Other features may enter in, as provisions to prevent the alienation of the stock held 1 Mason v. Curtis, 223 N. Y. 320 (1918); Palmbourne v. Magulsky, 217 Mass.3OO (1914). 467 468 CORPORATE LAW [Bk. I- by these trustees, and for special dispositions of the dividends thereon, etc., but these are inconsiderable and the designated exercise of the voting power of the trusteed stock for the given period is the main end sought. 2 It is to be noted that the objects attained by the voting trust can be secured more permanently by the formation of a "holding corporation," where this is permissible. 3 515. Distinctions The voting trust as here considered must be distinguished from the trust under which it was formerly attempted to mon- opolize certain industries. Under that plan the stock of a num- ber of otherwise competing corporations was placed in the hands of trustees, who were to manage them so that they did not cut prices or otherwise conflict with each other an arrangement that was held illegal and has been abandoned. The voting trust here considered affects only the stock of one corporation and that usually as to its voting rights, and has nothing to do with competition or prices. Neither has it any connection with the associations under deeds of trust, treated in later chapters, 4 which is an arrange- ment designed to effect an organization somewhat similar to the corporation* but free from the formalities and restrictions that hedge about the corporation. Nor has the arrangement here discussed any connection with restrictions on the sale of stock. Provisions restricting the sale of stock f6r a specified period or to anyone not embraced in the agreement may be included, but the voting restrictions are the main end of the trust and these others are merely incidental. The primary object of the voting trust here outlined, as inti- mated, is the continuance and perpetuation of a certain agreed management of one corporation. It concerns the stockholders 2 See Knickerbocker Inv. Co. v. Voorhees, 100 App. Div. (N. Y.) 414 (1905); see also Book IV, Form 104. See Ch. LVII, "Holding Companies." 4 Ch. LXIII, "Express Trusts as a Form of Business Organization," and Ch. LXIV "How an Express Trust Is Organized." Ch. 56] VOTING TRUSTS 469 of the particular corporation, and does not concern or affect in any way other corporations or persons dealing with the corpora- tion controlled by the voting trust. 516. How Formed A voting trust is formed by placing in the hands of trustees such proportion of the stock of the particular corporation as may be necessary to secure the desired control. These trustees act under, and their powers are denned by, an agreement styled the "voting trust agreement," subscribed to by all the parties entering the trust. 5 This agreement specifies the length of time for which the stock is to be held and the manner in which it is to be voted at the annual election of directors. If the manage- ment then in power is to be retained, the trustees would be instructed to cast the vote of the trusteed stock in all elections of directors for the parties then constituting the board, suitable provision being made in case of the possible death of any of the directors named. If the object of the trust were to insure minority representation on the board, the trustees would be in- structed to cast the trustee vote for directors in favor of parties named by the designated minority interests up to a specified number, the other members of the board being named by the majority interests. Or if the object of the trust were to secure an efficient and non-partisan board, the trustees might be in- structed merely to cast the vote of the stock held by them for such persons as in their judgment would be suitable and accept- able to the interests involved. The trust agreement might also provide the manner in which the trustees' stock is to be voted in matters of general interest, or it might be forbidden to vote on these matters, or its vote under such circumstances might be left to the discretion of the trustees. Whatever the instructions, the stock must be voted as a unit by the trustees, in accordance therewith, and, provided 8 See Book IV, Form 104. 470 CORPORATE 1,A\\ [Rk. I- the conditions of the trust be proper, the courts will enforce compliance. 517. The Stock hi Trust The stock included in a voting trust is actually transferred to the trustees and is by them taken out in their own names. Trustees' receipts are given to the parties depositing stock, these receipts being negotiable in form and representing the equitable ownership of the stock held in the trust. The trustees are authorized to collect and receive any divi- dends and profits accruing on the stock held by them, but must pay over the same in due proportion to the equitable owners of the trusteed stock. Often the trustees, for purposes of con- venience, direct the corporation to pay the dividends to the holders of the trust certificates. The trust agreement also provides the method of dissolution of the trust upon the expiration of the specified time limit, and any other desired features or details. In order to avoid any possibly illegal suspension of the rights of alienation in the stock held in trust, the agreement may provide that at any time, by consent of all the parties in interest, the trust may be terminated. 6 When it is desired to control but a single election, the use of proxies is the most convenient method by which this may be accomplished. These being revocable and of limited duration, are not available for more permanent purposes. 518. Legal Status New York and Maryland are the only states in which the voting trust is expressly sanctioned by statute. In New York this was done in 1901, when an amendment to the General Cor- poration Law was passed, providing: A stockholder may by agreement in writing, transfer his stock to any person or persons for the purpose of vesting in him, or them Williams v. Montgomery, 148 N. Y. 519 (1896). Ch. 56] VOTING TRUSTS 471 the right to vote thereon for a time not exceeding five years upon terms and conditions stated, pursuant to which such person or persons shall act; every other stockholder, upon his request there- for, may, by a like agreement in writing, also transfer his stock to the same person or persons and thereupon may participate in the terms, conditions and privileges of such agreement ; the certificates of stock so transferred shall be surrendered and canceled and certificates therefor issued to such transferee or transferees. . . . 7 The Maryland statute was passed in 1908 and follows the New York statute." Under these statutes a duplicate of the voting trust agreement must be kept on file in the principal business office of the cor- poration, open to the inspection of any stockholder during business hours. Prior to the passage of the statute, voting trusts existed in New York and were regarded favorably by the courts. Since its passage the conditions prescribed by the statute would probably have to be followed in detail to establish an enforceable trust. In New Jersey, Massachusetts, California, Alabama, New Hampshire, and other states, 9 although no statutes on this sub- ject exist, the courts have rendered decisions favoring similar arrangements and intimating that where the trust was for a proper purpose and for a reasonable time, and did not contem- plate any advantage from which other stockholders of the same corporation were excluded, it was not contrary to any principles of law or equity. In some courts there seems to be a strong feeling against the plan. In a comparatively recent case the Supreme Court of Illinois took the position that the plan was illegal and objection- able. The court said : The power to vote for directors can be exercised only by stock- holders in person or by proxy, and they cannot be deprived or ' Gen. Corp. Law (N. Y.). I 25. Md. Code, Art. 23, | 102. Chapman v. Bates, 61 N. T. Eg. 658 '(1900): Brightman v. Bates, I7S Mass. 105 (1910); Carnegie Trust Co. v. Security Life Ins. Co., in Va. n (1910). 47 2 CORPORATE LAW [Bk. I- deprive themselves of this power. Stockholders cannot evade the duty imposed upon them by law of using their power as stock- holders for the welfare of the corporation, and the general interest of its stockholders. A stockholder may refuse to exercise his right to vote and participate in stockholders' meetings, but he cannot deprive himself of the power to do so. 10 519. Illegal Voting Trusts The primary requisite of a legally defensible and enforceable voting trust is an object not illegal in itself, or calculated to injure or discriminate against other stockholders of the same corporation. The voting trust must also be reasonable as to its duration and terms, and its possible advantages should be open to all stockholders of the particular corporation. Any voting trust formed to promote a monopoly, or to domi- nate the corporation in the interests of another corporation, or to deprive other stockholders of any of their rightful powers, would undoubtedly be held illegal in any jurisdiction. 520. Restriction of Stock Sales ' The voting trust as a means of restricting the sales of the stock held under its provisions is of doubtful efficacy. It un- questionably prevents the transfer of the actual stock during the life of the trust, and thereby prevents the transfer of any of the stockholders' rights that would accompany delivery of the stock. On the other hand, the trustees' receipts, or certifi- cates, are transferable, and if the object of restricting the sale is to maintain the market price of the stock, or to give prefer- ence to the sale of treasury or other special stock, the sale of the trustees' certificates might interfere with these purposes almost as effectually as would the sale of the stock itself. The end desired may be effected in other ways. 11 10 Luthy v. Ream, 270 111. 170 (1915) "See J 553- CHAPTER LVII HOLDING COMPANIES 521. General A holding company, in the modern sense of the term, is a corporation formed for the express purpose of controlling other corporations by the ownership of a majority of their stock. 1 The advantages of a holding company may be enumerated as follows: 1. It furnishes a readily available and effective method of con- trolling several corporations for a common object. 2. It may be employed to perpetuate corporate control. Financiers holding the control of corporations may transfer their shares to a holding corporation. Death or disagreement will not then affect the control. In many cases also a holding corporation may take the place of a voting trust, which always is limited as to time. 3. The holding company permits the capitalization of con- trolling stock interests. The control of a corporation having a capital of twenty million dollars as an illustration requires a permanent investment of more than ten million dollars, assuming the stock worth par. If a holding corporation is formed with a capital equal to the investment, the shares may be transferred to it and forty-nine per cent of its stock sold. The original controlling stockholders, by retaining control of the holding corporation, retain control of the original corporation. 2 4. It may be used to form an effective organization of "Parent Company" and subsidiaries, for conducting various enterprises that require representatives in many states. Under the common law, which did not permit one corporation to invest in the stock of another, holding corporations were 1 See Book II, 5 44-48; also Bo9k III, Ch. XXVII, "Holding Companies." * Noyes on Intercorporate Relations, } 285; see also 14 Corpus Juris, p. 284. 473 474 CORPORATE LAW [Bk. I- impossible and any attempt of a corporation to control another corporation by holding a majority of its stock would have been held ultra vires. The charter of a corporation is the measure of its powers. It can exercise only such powers as are conferred upon it, either in express terms or by necessary implication, in the law of its creation. The purchase of stock in another corporation involves a partici- pation in a new and distinct enterprise. A corporation can make such a purchase only when expressly authorized to do so by the statute, or when the power can be implied as incidental to the powers specifically granted. 3 But as the powers of corporations, created by legislative act, are limited to such as the act expressly confers, and the enumeration of these implies the exclusion of all others, it follows that, unless ex- press permission be given to do so, it is not within the general powers of a corporation to purchase the stock of other corporations for the purpose of controlling their management. 4 Corporations have certain incidental powers of acquiring and holding stock, as discussed in the section which follows. The general right to purchase and hold the stock of other cor- porations, under which the holding corporation is possible, is, however, derived from legislative enactment, either by virtue of statutes expressly conferring on specific corporations the power to buy and hold the stocks of other corporations, or in a few states under the operation of statutes permitting the formation of corporations for any legitimate purpose. 5 In many cases companies are incorporated in those states that permit special provisions authorizing the holding of stock of other corporations, in order to secure such right definitely. Ji:j-|rM .. 522. Incidental Powers to Hold Stock In many cases corporations have power to take and hold stock in other corporations as a power incidental to their main 1 Noyes on Intercorporate Relations, }} 264, 274; People v. Pullman Co., 175 111. 123 (1898); 64 L. R. A. 366; People v. Chicago Gas Trust Co., 130 111. 268 (1889); Hyams v. C. & H. Mining Co., 221 Fed. 529, 537 (1915). 4 De La Vergne Co. v. Savings Institution, 175 U. S. 40, 54 (1899). 6 Dittman v. Distilling Co., 64 N. J. Eq. 537 (1903); Market St. Ry. Co. v. Hellman, 109 Cal. 571 (1895). Ch. 57] HOLDING COMPANIES 475 purpose. For instance, certain corporations, like the great insurance companies which in the regular course of business have large sums for investment, are very properly allowed to invest these in safe stocks. Also in almost all cases corporations are allowed to take corporate stock to save a debt. They may also take stock as collateral to secure an obligation, which in the usual course of business may bring about their ownership of such collateral. Where a corporation may lawfully consolidate with another corporation, it may acquire the stock of this other corporation as a proper step to such consolidation. But a corporation authorized to acquire and hold stocks of other corporations cannot in this way control companies in states where such stockholding is unlawful. 6 Also in some cases it has been held that a corporation may take stock in another corporation when this other corporation will promote some of its specified purposes, as when a street-car company takes stock in a hotel or amusement park on or near its lines, or a manufacturing company takes stock in a power development company from which it will obtain power. 523. Authorization to Hold Stock New Jersey was the first state to enact statutes specifically empowering corporations organized under its laws to hold the stock of other corporations. This law was first adopted in the year 1888, and read as follows: Any corporation may purchase, hold, sell, assign, transfer, mortgage, pledge or otherwise dispose of the shares of the capital stock of, or any bond, securities, or evidences of indebtedness created by any other corporation or corporations of this or any other state, and while owner of such stock may exercise all the rights, powers and privileges of ownership, including the right to ^vote thereon.' Hill v. Nisbet, 100 Ind. 341 (1884); Coler v. Tacoma Ry. and Power Co., 65 N. J. Eq. 347 (1903). 7 See Gen. Corp. Law of New Jersey, { 51. 476 CORPORATE LAW [Bk. I The enactment of this law by New Jersey paved the way for the great industrial combinations. Theretofore such com- binations had been attempted by the appointment of a board of trustees in whose hands was placed a majority of the stock of the corporation to be controlled, these trustees then electing boards of directors which managed their respective corpora- tions in the common interest. This arrangement was declared illegal and was abandoned for the holding corporation under the New Jersey law. 8 In 1913, however, in an effort to check the opportunities for monopolistic combination, holding companies were abolished by a drastic piece of legislation known as "The Seven Sisters." Later and by degrees all of these acts were repealed or super- seded, and now all that is prohibited is the holding of the stock of other corporations to restrain competition or to create a monopoly. The statute as it now stands insures to corporations the usual 'incidental powers to hold stock of other corporations. 9 The federal decisions declaring certain of these holding cor- porations illegal are not directed against the laws under which they were formed, but against the purposes of the corporations. Delaware and Maine have enacted statutes similar to the earlier statute of New Jersey, giving corporations the unlimited power to buy, hold, and sell stocks; and in New York these privileges may be enjoyed if so provided in the charter. Under the Maine statute it has been held that a corporation organized under the law regulating the incorporation of general business corporations, could not acquire stock in companies organized to do insurance business, thus doing indirectly what it could not do directly. 10 524. What Holdings Carry Control Contrary to popular opinion, it is rarely necessary to hold 51% of the outstanding stock of a corporation in order State v. Standard Oil Co., 49 Ohio St. 137 (1892); People v. North River Sugar Refining Co., 121 N. Y. 582 (1890). > Gen. Corp. Law of New Jersey, as amended (1920), { 134. 10 Central Life Securities Co. v. Smith, 236 Fed. 170 (1916). Ch. 57J HOLDING COMPANIES 477 to elect a majority of the directors, and through them to elect the officers and control the corporation. Where all the stock is held in a few hands, as in a close corporation, the case is differ- ent, but even here anyone holding or controlling half the stock can, if he once obtains a majority of the board, hold his control indefinitely. A majority against him cannot be obtained, and if a deadlock should arise over the election of directors, no new directors could be elected without his consent, and his directors, already in office, would hold over until some agreement satis- factory to him was reached. With the usual corporation with scattered holdings, a much smaller proportion than half the stock is sufficient to control. In an action under the Sherman Anti-Trust Act, the Supreme Court held that the purchase of 46% of the stock of a competing railroad was ample to control its operations, thereby effecting a combination in restraint of trade. 11 ' The president of one of the largest railroad systems in the United States is authority for the statement that 33 per cent of the stock which has voting power is sufficient to control any important railway, always excepting instances where great blocks of stock are centralized in a few hands. He added that those in control of a property could always count upon a large proportion of the stock- holders supporting them as a matter of course, because such holders were too weak or too lazy to engage in any independent movement of their own. In the case of banks and trust companies, 33 per cent holdings are nearly always sufficient to protect an existing management. That is the basis usually followed by new interests in attempting to buy up properties, and with the trust companies especially such holdings have almost invariably been sufficient to force recognition from an unwilling management. One bank president of this city has been known to own personally 40 per cent of the stock of his own bank, which was unusually heavily capitalized. With such holdings and those of his friends, the present owners could not pos- sibly be dislodged. The president of another bank, following a different method, has taken care to see that its stock is distributed " United States v. Union Pac. R. R. Co., 226 U. S. 61, 96 (1912). 4?8 CORPORATE LAW [Bk. I- as widely as possible, so that today, with a comparatively small capitalization, the bank is owned by at least two thousand different stockholders, who could hardly be combined against the manage- ment. 12 It is reported that when the control of the Western Union Telegraph Company passed to the Bell Telephone interests, it was effected by transfer of but 20% of the outstanding stock. 525. Its Function in Industrial Combination The holding corporation has occupied a position of great importance, it being the means by which many of the great industrial combinations were effected and controlled. Some- times these corporations were confined strictly to the function of holding companies, as was the case with the Northern Securi- ties Company which was formed for the sole purpose of holding sufficient stock of the Great Northern Railway Company and the Northern Pacific Railway Company to control the two corporations and combine their interests. Usually, however, such a corporation was given, in addition, ample powers to carry on directly any business or industry in the line of the proposed combination. Then it could operate by controlling the majority of the stock of its component corporations, or by buying up the manufacturing plants engaged in the particular industry, or by initiating new industrial operations on its own account, or by doing all of these things. As already suggested, the holding corporation itself could be controlled by the ownership of but 50% or 51% of its stock, and so long as the parties in control hold this amount, they could part with any additional stock without interfering with their control of the holding corporation and through it of the subsidiary corporations. This device made it possible for those who were on the inside to control much capital with a compara- tively small investment on their own part. 13 " Editorial New York Evening Post. 11 See i Cook on Corp., } 317; Noyes on Intercorporate Relations, 5 285 it seq.; Robotham v. Prudential Insurance Co., 64 N. J. Eq. 673 (1903). Cb. 57] HOLDING COMPANIES 479 526. Limitations on Use of Holding Companies The holding corporation is the instrument by which 'most of the great industrial combinations have been effected, and has oeen generally recognized as the proper legal means to this end. Most of these great industrial combinations and many of the smaller ones as well have, however, come to grief through the enforcement of the Sherman Anti-Trust Law. At the present time a holding company organized in one state may control corporations organized under the laws of other states. 14 It is within the power of any state objecting to this, to pass laws to prevent foreign holding corporations from con- trolling corporations formed under the laws of such states; or the courts may declare such control illegal and therefore impos- sible. is With a view to simplifying corporate relations, it is probable that such action on the part of the states would be of advantage. The same end might be achieved by means of a statute denying the right to vote at corporate elections to all stock except that owned by natural persons in their own right. This would effectually prevent the operation of the holding cor- poration. In the Northern Securities case, the United States courts held the attempt to prevent competition between two opposing interstate railways by means of a holding corporation illegal. 16 In the famous cases against the Standard Oil Company and the American Tobacco Company the Supreme Court held that the use of holding companies as a means of controlling competing companies where such control resulted in a violation of the Sherman Anti-Trust Law, was illegal. 17 The Clayton Act of October 15, 1914, makes the law very specific as to corporations engaged in interstate commerce, and forbids the acquisition by one corporation of the whole or any M Island Heights, etc., Co. v. Brooks & Brooks, 88 N. J. L. 613 (1916). " Central L. S. Co. v. Smith. 236 Fed. 170, 176 (1916). 18 See Northern Securities Co. v. United States, 193 U. S. 197 (1004). " Standard Oil Co. v. United States, 221 U. S. i (1911); United States v. American Tobacco Co., 221 U. S. 106 (1911). 480 CORPORATE LAW [Bk. I- part of the stock of another corporation, "where the effect may be to substantially lessen competition between the corporation whose stock is so acquired and the corporation making the ac- quisition, or to restrain such commerce in any section or com- munity, or tend to create a monopoly of any line of commerce." It may be 'said that at this time any arrangement of holding companies, or any other combination of corporations to prevent competition, restrain trade, or enhance prices, is illegal and will be dissolved by the courts. In a remarkable case in New Jersey, 18 minority stockholders sought to enjoin the directors of the Prudential Life Insurance Company from carrying out an arrangement by which the Fidelity Trust Company was to con- trol the Prudential Company, and the Prudential Company in its turn was to control the Fidelity Trust Company. Under this plan, at the next ensuing election which was that of the Trust Company, the Prudential directors, voting a majority of its stock, would have put themselves in charge of the affairs of the Trust Company. Then when the time came for the Prudential election, these same directors, exercising the Trust Company control, would in like manner have put themselves in charge of its affairs, and thereafter the interlocking board thus formed would have been self-perpetuating, and the enormous assets of the Prudential Insurance would have been controlled by the board in perpetuity. In the course of his argument, counsel for the directors asserted that under the laws of New Jersey the following plan would be entirely legal : One man controls a company of $10,000,000 capital. He may form a new company with a capital of $5,100,000 to hold a majority of the stock. He may then sell all but $2,600,000 of the stock in company No. 2 and transfer his remaining stock to a new company with a capital of $2,600,000. He may then sell to company No. 3 all but $1,400,000 and transfer that to a new company. This process may go on until the power of the whole chain of corpora- w Robotham v. Prudential Insurance Co., 64 N. J. Eq. 673 (1903). Ch. 57] HOLDING COMPANIES 481 tions is vested in the holder of a few thousand dollars of stock in the ultimate company, and the same chain can be used for an unlimited number of companies. ft >nrf tl >nr,;t,. Vice-Chancellor Stevenson, before whom the case was heard, apparently did not sympathize with this view of the possibilities of holding companies under the New Jersey law, and expressed his views with some emphasis. The court also granted the injunction asked for, thereby indicating that the mutual control of each other by two corporations is not under existing laws a legal possibility. In any case of abuse of power by means of a holding cor- poration, the courts would undoubtedly afford relief. 19 527. Parent Companies A useful variant of the holding company is frequently em- ployed with advantage in the exploitation of inventions. A parent corporation, in which the patent rights for such inventions are vested, is formed in some selected state where the power to hold the stock of other corporations may be had. Subordinate companies are then formed in the several states or other terri- torial districts, and to these companies rights in the invention are assigned for their respective districts, the parent company usually reserving or acquiring a controlling interest in each subordinate company. The patent rights may be sold to the subcompanies absolutely, or with reservation of royalties, or perhaps a mere license may be issued. The subordinate com- pany then operates in its own territory as an independent com- pany but under the general direction of the parent company, this direction becoming immediate and absolute in case of necessity. Under this plan the parent corporation makes certain the proper fulfilment of its contracts with the subordinate companies, and insures the harmonious conduct of the general business. 20 "See Farmers' Loan & Trust Co. v. N. Y., etc., R. Co., 150 N. Y. 410 (1896); Nilev. N. Y. C. & H. R. R. Co., 69 App. Div. (N. Y.) 144 (1902); contra, Windmuller v. Distilling Co., 114 Fed. 491 (1902). 20 For further discussion of this subject, see Book II, 48; also People v. Am. Bell Tele- phone Co., 117 N. Y. 241 (1889). 482 CORPORATE LAW [Bk. I- 528. Powers of a Corporate Stockholder Where a corporation has the right to hold the stock of other corporations, it has all the rights and privileges that an indi- vidual would have. Such stock is personal property of the corporation, is liable to taxation as such, and all its corporate rights and privileges are maintained in full vigor. It participates to the full in any dividends declared by the corporation from which it issued, and is entitled to full representation and voting rights at any stockholders' meeting of that corporation. Such stock would be voted, either in person or by proxy, by the trustee or official in whose name it was held, or, if held in the name of the corporation, by such person as was formally desig- nated thereto by the corporation. Such vote would be cast under the general instructions of the board of directors of the holding corporation, but unless matters of much importance were to be considered, no detailed instructions would be given, all this being left to the discretion of the person who represented the corporation. If matters of much importance were to be considered, the representative might be instructed with pre- cision as to his position and his vote. CHAPTER LVIII PROTECTION OF MINORITY STOCKHOLDERS 529. General The corporate rights of minority stockholders are at the best much circumscribed, and those that do exist are frequently disregarded and are then difficult of enforcement. Not infre- quently, actions of the directors infringing minority rights are not discovered by the minority until too late for prevention or protective action, and legal redress is as a rule slow, costly, and inadequate. Such protection as may be secured to the minority in the organization of the corporation is therefore a matter of importance. When the parties in control of an incorporation are willing to recognize the rights of the minority stockholders, or are compelled thereto by the conditions, it is quite possible for the minority to secure efficient protection for such rights as are properly theirs. Unfortunately the interests which control at the time a corporation is organized are too often indifferent or actually inimical to the rights of the minority stockholders, and these then receive no consideration, save such as is compelled by statute law or by respect for the sensibilities of the investing public. 530. Rights of Minority at Common Law Under the common law which still prevails save where and as superseded or modified by statute law the rights of minority stockholders were not extensive. They were entitled to be present and participate at stockholders' meetings. They were entitled to inspect the corporate stock books during the usual hours of business and copy the names therein if they so 483 484 CORPORATE LAW [Bk. I- desired. They also had the right under reasonable conditions to inspect the books of account. Also under the common law a few important matters, such as amendment of the charter and the sale of the entire corporate assets, required authoriza- tion by unanimous vote of the stockholders, and this require- ment gave the minority a certain veto power in such matters. At stockholders' meetings the minority might assist in the de- liberations, but the majority had absolute power to adopt by- laws and to elect the entire board of directors. The minority might not even have a representative present at board meetings save by grace of the majority. 531. Modern Abridgments of Minority Rights As already intimated, minority rights under the common law were, at the best, somewhat slender. At common law the minority had the right at reasonable times to inspect the books and accounts of the corporation. This right has been so narrowed down by latter-day statutes and decisions that it is in many states negligible. In New Jersey it is customary to limit this privilege still further to such inspection as the directors may prescribe. Even the stock and transfer books may be seen only under restrictions. As to books of account, this change of custom is probably necessary. If it were otherwise, business competitors might avail themselves of the formerly easily acquired right of inspec- tion of the books to obtain information and trade secrets to the injury of the corporation. 1 Also, with the many stockholders and the complex accounts of modern corporations, the right if freely exercised would interfere with the regular transaction of business. While this is true, some substitute for the stockholders' in- spection of the books of account should be provided that, without injury to the corporation, would give to the stockholders proper information as to the status of the corporate business. 1 In re De Vengoechea, 86 N. J. L. 35 (1914). Ch. 58] PROTECTION OF MINORITY 485 To deny it entirely is a flagrant and unjustifiable disregard of the rights of those whose property is at stake. The abridgment of the stockholders' right to inspect the stock and transfer books is to be viewed with distrust. There would seem to be no proper reason for concealing from a stock- holder the identity of his fellow stockholders. The right to make a list of these stockholders is properly denied him if such list is for stock-selling purposes, for sale to other parties, for general circularization, or for similar purposes, but should not be refused if the list is desired for proper purposes. Again, the right to make by-laws was f ormerly a prerogative of the stockholders alone, and these by-laws usually imposed certain proper restraints and limitations upon the directors. Now, in New Jersey and a few other states, by charter pro- vision it is possible and not uncommon to give the directors absolute power to repeal by-laws passed by the stockholders, and to substitute, if they so desire, by-laws of their own of exactly opposite effect. This was a concession to the needs of the "trusts" with their centralization of power and their entire subordination of the individual stockholder, and is perhaps the most dangerous of all the innovations upon the old rules, as it virtually releases the directors from all necessity for compliance with the wishes of the stockholders, and leaves in their hands the unrestrained management of the corporate affairs. It will be understood without discussion that any change in the law acting to increase the powers of the directors, or to remove or prevent limitations thereon, distinctly augments the power of the majority. The board is elected by the majority, and any restraining influences that exist upon the power of this board which represents the majority must be found in the charter, by-laws, and statutes. If, then, the statutes are re- laxed, charter limitations omitted, and the board itself given the power to make and amend by-laws, the power of the board as the representative of the majority is greatly increased, and the minority interests become in effect a negligible quantity. 486 CORPORATE LAW [Bk. I- Also the charter may be more easily amended than formerly. In New Jersey such amendment may be accomplished by a two-thirds vote of the stockholders, in New York by a three- fifths vote, and in Delaware by a bare majority in interest. This latter is a somewhat remarkable relaxation of the former rule, and apparently permits a mere majority to change the entire nature of the corporate business, as for example, to divert capital invested for the purpose of developing a publishing business into the exploitation of a mining claim. It is doubtful whether material change in the charter should be allowed under any circumstances, unless by the practically unanimous vote of all concerned. In consequence of these tendencies the present condition of the minority stockholder, unless special provision is made for his protection, is even less satisfactory than it formerly was under the common law, 532. Measures to Protect the Minority The legitimate ends sought by the minority are honesty, efficiency, and reasonable publicity of management a manage- ment for the good of all and not one primarily in the interests of the majority. The means that may be employed to secure these ends are of two general classes, the one consisting of such arrangements, modifications, or restrictions of the voting power as to secure to the minority at least a reasonable representation on the board of directors; the other consisting of provisions in charter or by-laws restraining and regulating the powers of the board and prescribing safe rules for the conduct of the business. The first-mentioned method is the most effectual for the protection of the minority interests. The usual cases of oppres- sion or fraud on the part of the majority occur in the absence of minority representation on the board. If the minority have one or more directors on the board, the majority will still, as a matter of course, control, but it is in the highest degree improb- Ch. 58] PROTECTION OF MINORITY 487 able that this control will be exercised to the injury of minority interests. If any such attempts are made, the minority stock- holders through their representatives on the board will be fully cognizant of the proposed action, may enter such immediate protests and make such representations as they see fit, and, if such prejudicial action is persisted in, may take prompt legal action to protect their interests. Without this board representation, charter and by-law pro- visions for the protection of the minority are apt to be of but little effect. With board action free from supervision and with the assistance of counsel skilled in evasion of the law, such un- supported provisions may be easily overcome or avoided. With an intelligent minority representation on the board, such in- fringements of minority rights would not usually even be contemplated. The usual measures for the protection of minority interests are considered in the following sections of the present chapter. 533- Cumulative Voting Cumulative voting is one of the most effectual means of securing minority representation on the board of directors. So highly are the results of this system esteemed .that its use in cor- porate elections is prescribed by constitutional provisions in Pennsylvania, Illinois, California, and a number of other states. In New York, New Jersey, and some other states it may be used if so provided in the corporate charter. The Constitution of the state of Pennsylvania outlines the system with much conciseness, as follows: In all elections for directors or managers of a corporation, each member or shareholder may cast the whole number of his votes for one candidate or distribute them upon two or more candidates as he may prefer. The New York statutes go into the matter more fully: The certificate of incorporation of any stock corporation may provide that at all elections of directors of such corporation each 488 CORPORATE LAW [Bk. I- stockholder shall be entitled to as many votes as shall equal the number of his shares of stock multiplied by the number of directors to be elected, and that he may cast all of such votes for a single director or may distribute them among the number to be voted for, or any two or more of them as he may see fit, which right, when exercised, shall be termed cumulative voting. 2 Under this system the majority control and manage the corporation absolutely, but the minority stockholders, if their holdings are at all material, can always elect one or more direc- tors to represent them. If they elect capable men, there is but little danger that the minority interests will suffer. To obtain the best results from cumulative voting, the minority must be organized to some extent at the time of the annual election, and should delegate by proxy to some few trusted representatives the casting of their ballots. To cast these aggregated votes to the best advantage some- times requires nice calculation. For instance, in a corporation with a board of five directors and 100 shares of voting stock, each share will have the right to cast 5 votes, or a total for all the voting stock of 500 votes. In such case any person or per- sons controlling 17 shares can cast 85 votes, and if this total vote is cast for a single candidate this candidate would infallibly be elected. The aggregate of the other votes cast would be 415, but no matter how they were divided among the other candi- dates, the candidate with 85 votes could not be defeated. If evenly divided among the five aspirants for board membership, each would receive 83 votes, but the minority candidate with 85 votes would have a plurality of the votes cast, and would under any circumstances have enough votes to insure his elec- tion. Some preliminary calculation is always advisable. There are no material objections to the system of cumulative voting, and it should be adopted wherever possible. Its in- creasing use is a practical testimonial to its value. It must, however, be used with intelligence, or the results are sometimes Gen. Corp. Law. N. Y., 5 24. Ch. 58] PROTECTION OF MINORITY 489 surprising. On occasion an unsuspecting majority have so scat- tered their votes that a compact, well-handled minority have actually gained control of the board. In other words, the majority threw themselves into a minority by scattering. For instance, in the example given above, if the minority, instead of controlling but 17 shares, controlled 45 shares of stock, they would be able to cast 225 votes as against 275 votes cast by the majority. The minority might then very safely divide their votes among three candidates, with the assurance that they would elect at least two directors and might elect the third. The majority would have votes enough to elect three directors, but if they thoughtlessly scattered those votes among four or five candidates, the three minority candidates, with over 70 votes each, would be elected and would control the board. Such an election, though somewhat unexpected in its results, is legal and would be upheld wherever cumulative voting is prop- erly employed. 3 534. Classification of Stock Where definite divisions of interest exist among the stock- holders, or intending stockholders, at the beginning of the cor- porate organization, classification of stock, where allowable, may be employed with entire confidence that each class will receive due representation on the board. Such classification is permitted in most states, and should be secured by charter pro- vision where possible; elsewhere by by-laws adopted before stock is issued. By-laws of this nature, so adopted, become in effect a contract with those purchasing stock and hence are not susceptible of repeal save by consent of all interests. 4 Under such an arrangement stock may be divided into any classes desired, equal or unequal in amount. To each of these classes may be assigned one or more directors, and so long as the corporate organization exists unchanged, each of these See { 237- 4 Kent v. Quicksilver Mining Co., 78 N. Y. 139. 178 (1879); Loewenthal v. Rubber Rec. Co., 52 N. J. Eq. 440 (1894)- CORPORATE LAW [Bk. I- classes will elect its own directors to the board. This arrange- ment is very effective. 5 535- Voting Trusts The general subject of voting trusts has already been con- sidered. 6 It is referred to here only as a method of protecting minority rights where these interests are in a position to demand such protection before entering the corporation. This may occur where stock in a corporation is offered for property, or where a partnership is to be incorporated with some of the partners holding comparatively small interests. In such event the proposed investment or arrangement may be acceptable to the parties concerned, even though it places them in a hopeless minority, if they can be assured of represen- tation on the board, or that an acceptable management will be elected and retained for at least a reasonable length of time. In any such case the desired end may be effectually secured by means of the voting trust. In this connection it may be noted that a mere agreement between parties holding stock, that such stock shall be voted for certain persons or in a prescribed manner, will not be enforced by the courts even though this agreement be embodied in a formal contract. Under some circumstances damages might be obtained for breach of such a contract, but the contract itself could not be enforced and damages would usually be very difficult to prove. 7 536. Special Arrangements Many other arrangements for the protection of the minority or of particular interests are possible, depending upon the cir- cumstances, the statutory provisions of the state of incorpora- tion, and the decisions of its courts. * See 221; also J 547, which explains how the plan may be used when a partnership is incorporated. See Ch. LVI, "Voting Trusts." ' Gage v. Fisher, 5 N. D. 297 (1803). Ch. 58] PROTECTION OF MINORITY 491 In those states where special provisions may be inserted in the charter, it is entirely possible, in the absence of express constitutional and statutory prohibitions, to decrease the pro- portionate vote of the stockholder as his holding increases, or to deny the voting right absolutely after a certain maximum vote has been reached. For instance, it may be provided that each stockholder shall cast one vote for each share of stock held by him up to a total of 10 shares; that on stock in excess of this amount up to 100 shares, he shall have one vote for each 5 shares; that on all stock in excess of 100 shares he shall have one vote for each 10 shares. This is the voting provision of the English Companies Act which has some merits. Any other apportionment of the voting power may be made, or it may be provided that after some maximum vote has been reached, as for instance 10 votes for 10 shares held, no further vote shall be cast by such stockholder no matter what his holding. It is also possible to place the number of votes necessary to elect a director so high that under any ordinary circumstances directors cannot be elected save by agreement. For instance, if a three-fourths vote of the outstanding voting stock were neces- sary to elect, it would be but seldom that the majority could elect without minority assistance. Then they must either allow the management to remain without change, as will be the case if there is no election, or unite with the minority to elect. If this were necessary they would hardly propose anyone objec- tionable to the minority element. This plan presupposes an existing management acceptable to all the stockholders. 537. Annual Audits In the larger corporations the auditing of the books of account is a very important feature of the corporate operations and, if properly conducted, may be made to eliminate any neces- sity for the inspection of such books by the rank and file of the stockholders. Such auditing may be annual, quarterly, or held at irregular intervals, and, if made by proper parties, serves 49 2 CORPORATE LAW [Bk. I- both as a check on the management and a verification of their accounts, The results of these audits give the stockholders the general information in regard to the business that they have a right to demand, and, as intimated, thereby remove the necessity for examination of the accounts by these latter. It is, of course, imperative that the professional accountants employed as audi- tors be absolutely reliable and thoroughly qualified for their work. 538. Charter Limitations In New York, New Jersey, and some other states, limitations on the power of the majority may be inserted in the charter. At the inception of the enterprise the minority are not infre- quently in a position to demand the inclusion of such limitations as a condition precedent to their participation in the corpora- tion. Even if otherwise, an era of good feeling generally exists at this stage of the enterprise, and reasonable concessions may then be obtained which later would not be possible. The minority have a right to ask safeguards as a condition of their investing. An instance is afforded by the charter of one of the prominent industrial trusts in which the following provision is found: "It is hereby provided that it shall require a majority of seventy- five per cent of the outstanding voting stock to amend the charter, to amend the by-laws, or to elect directors in this company." Such a provision is directly in the interests of the minority. In this case it may have been conceded voluntarily, but prob- ably its adoption was demanded by some of the smaller but necessary component corporations as one of the conditions of their entrance into the combination. Under such a provision no changes could be made in charter, by-laws, or the board of directors against the wishes of a minority controlling 26% of the voting stock. Under such circumstances a minority judiciously handled could always protect its interests. This Ch. 58] PROTECTION OF MINORITY 493 arrangement cannot be had in New York as the statute specifies that directors shall be elected "by a plurality of the 'votes at such election." As damage to minority interests or the wrecking of cor- porations is almost invariably caused by improvident contracts, unwarrantable salaries, or excessive indebtedness, charter limi- tations upon the power of the board in these directions are of frequent occurrence. Some flexibility is usually given to these restrictions by provision that their limits may be exceeded by a unanimous vote of the board, or by a two-thirds or three- fourths vote of the outstanding voting stock, or by some similar provision. Where these limitations exist, it is important that some such flexibility be provided, as otherwise the interests of the corpora- tion might on occasion suffer severely. The limits of charter provisions cannot be legally exceeded by the corporation, either by action of the directors or stockholders, except as specifically allowed by the charter itself, and business opportunities of obvious advantage to the corporation might be lost for lack of the power to meet their terms or conditions. It is also possible to provide in the charter that the minority may have reasonable access to the books and records of the corporation, and any other desired privileges not in conflict with the statutes may be so secured. 8 539. Legal Remedies Prevention of wrong is better than any remedy, but a knowl- edge of their rights and the remedies that the law gives for in- fringement of their rights is sometimes of much advantage to minority stockholders. The usual methods of wronging minority stockholders, such as paying inordinate salaries, withholding dividends, selling or leasing corporate property below its worth, running the corporation into debts which it cannot me,et, and similar fraudulent and oppressive transactions, are all illegal See Ch. XXVI, "Charter Special Provisions." 494 CORPORATE LAW [Bk. I- and tortuous. For all of these wrongs the law will give redress if those 'who suffer will seek it. When salaries are wrongfully increased the courts will com- pel restitution, and in such case the whole of the inordinate salary must be returned, not merely the excess. Directors are trustees and cannot use their power as such to enrich them- selves. Neither can this just rule be evaded by each director's not voting on his own salary but letting it be fixed by his brother directors. 9 Directors, like promoters, will be compelled to ac- count for any secret profit which they may make in any trans- action in which the corporation is interested. 10 The directors control the declaration of dividends. "When a corporation has a surplus, whether a dividend shall be made, and if made, how much it shall be, and when and where it shall be payable, rest in the fair and honest discretion of the directors uncontrollable by the "courts." 11 But if this discretion is not honest and fair, and dividends are withheld to discourage minor- ity stockholders and induce them to sell their stock at low prices, the courts will interfere on behalf of the minority. 12 In a New York case the court said : This is one of those cases where a majority of stockholders have entered into a combination to control the affairs of the corporation for their own benefit and in fraud of the rights of the minority. Such a combination will always be rebuked by a court of equity. . . . Directors of a corporation have no right to vote salaries to one another as mere incidents of their office, as was done here. 13 Another device for robbing minority stockholders is to make improvident contracts, usually with some other organization with which the offending directors are connected. Many such Davids v. Davids, 133 App. Div. (N. Y.) 206 (1909); Jacobson v. Brooklyn Lumber Co., 184 N. Y. 152 (1906); Luthy v. Ream, 270 111. 170 (1915). 10 Billings v. Shaw, 209 N. Y. 265 (1913)- " Williams v. W. U. Telegraph Co., 93 N. Y. 162, 191 (1883). ' Hiscock v. Lacey, 9 Misc. Rep. (N. Y.) 578 (1894); Belfast, etc., Co., v. R. R. Co., 77, Me. 445 (1885). 13 Fitchett v. Murphy, 46 App. Div. (N. Y.) 181 (1899); Bixler v. Summerfield, I9S 111. 147 (1902). Ch. 58] PROTECTION OF MINORITY 495 cases have come under the condemnation of the courts. 14 In such a case the Supreme Court of the United States said : All arrangements by directors of a railroad company, to secure an undue advantage to themselves at its expense, by the formation of a new company as an auxiliary to the original one, with an under- standing that they, or some of them, shall take stock in it, and, that valuable contracts shall be given to it, in the profits of which, they as stockholders in the new company, are to share, are so many unlawful devices to enrich themselves to the detriment of the stock- holders and creditors of the original company, and will be con- demned whenever properly brought before the courts for consideration. 1 * Such transactions being fraudulent cannot be authorized or ratified by a majority of the stockholders. 16 When the corporation is wrecked by purposely running it into debt, necessitating a receivership and subsequent reorgan- ization, out of which the wreckers in some form profit, it is usually difficult to prove the wrongdoing. Bad management in good faith is so common that it is not easy to draw the line and show in any particular case that the mismanagement was intentional. Where the directors do not use ordinary care and diligence in the discharge of their duties, they are liable for the damage caused by their negligence. 17 In practice, however, it may be very difficult to prove such negligence as will entitle the com- plaining stockholders to damages. In one notable case the United States Supreme Court evidently allowed its sympathies to warp its judgment. 18 The minority stockholders may also, under certain condi- tions, obtain redress against the majority stockholders. As the directors are the managers of the corporate business, they are 4 Sage v. Culver, 147 N. Y. 241 (1895); Schwab v. Potter Co., 194 N. Y. 409 (1909). * Wardell v. The Railroad Co., 103 U. S. 651 (1880). Dana v. Morgan, 219 Fed. 313 (1914); Pollitz v. Wabash R. R. Co., 207 N. Y. 113. "7 (1912). 7 3 Cook on Corp-, { 702, and cases cited; Chick v. Fuller, 114 Fed. 22 (1902). Briggs v. Spaulding, 141 U. S. 132 (1891). 496 CORPORATE LAW [Bk. I- usually the persons responsible for the infringement of the minority stockholders' rights. However, it is not infrequently the case that another corporation or group of men obtain con- trol of the corporation and proceed to employ it to further their own interests. In such cases it has been held that those who. control the majority of the stock occupy a fiduciary relation towards the minority, and that acts in their own interest to the detriment of the minority stockholders are wrongs for which the court will give relief. 19 The practical difficulty is that the archaic and clumsy pro- cedure of our courts makes litigation so slow and so expensive that the ordinary citizen cannot afford, in most cases, to seek the redress to which he is entitled. By the theory of the law he may right his wrong, but in practice the cost and delay of litigation make it impossible. iBoyd v. N. Y. & H. R. Co.. 220 Fed. 174 (1915); Hyams v. Calumet & Hecla Mining Co., 221 Fed. 529 (1915); Union Pac. R. Co. v. Frank, 226 Fed. 906 (1915); McManus v. Durant, 168 App. Div. (N. Y.) 643 (1915). CHAPTER LIX INCORPORATING A PARTNERSHIP 1 540. General The incorporation of a partnership involves problems differ- ing from those of the incorporation of a new enterprise. These problems vary with the conditions and requirements of the par- ticular partnership. If the partners are willing to adopt the simplest and most obvious corporate arrangements; if they will capitalize at the actual values-; issue all the capital stock in payment for the values transferred to the corporation; allot this full-paid stock to the various partners in the proportion of their partnership interests, and thereafter let matters take their natural corporate course, the duties of the incorporating counsel are not onerous. Usually, however, the parties to such an incorporation are not willing to commit themselves so irrevocably to the operations of the unmodified corporate system. They are accustomed to the conditions of the partnership, and they wish these approxi- mated as nearly as may be under the new regime. Possibly all the partners, without regard to investment, may be participating equally in the management; or one partner, with a relatively small investment, may be the leading spirit and practically in control; or a silent partner, taking no active part in the management, may have a preponderant investment. In any of these cases, the ordinary operations of the corporate system would work a radical change, and it is not to be supposed that the partners would agree to the entire abolition of the con- ditions under which perhaps they have achieved success. On the contrary, they usually desire to continue the existing condi- 1 See also Book III, Ch. XVII, "Incorporation of a Partnership." 497 498 CORPORATE LAW [Bk. I- tions. This may be done with much precision, for nowhere does the flexibility of the corporate system appear to better advantage than in its ready adjustment to the varying needs of partnership incorporations. 541. Name The partnership name should in itself represent a consider- able trade value that would be lost if it were dropped on incor- poration. To avoid this, the name of the partnership is usually adopted, as nearly as may be, as the name of the new corpora- tion. In those states where it is permissible, the partnership name is not infrequently taken without modification as the corporate designation. This practice is, however, open to objection, as there is then nothing in the corporate name to indicate that the concern is a corporation, and 'parties doing business with it might, unless informed of its corporate nature, be able to hold the stockholders as partners. Such a possibility largely eliminates the most advantageous single feature of incorporation its limited liability and to retain this feature, while still preserving the actual form of the partnership name, the word "Incorporated" or the abbreviation "Inc." is frequently added. This usually appears in small letters after the name, sometimes in parentheses, and effectually prevents any danger of partnership liability. In some states the word "Company" must form part of every corporate name, arid in these states the usual practice when a partnership is incorporated is to adopt the partnership name with the prescribed word following "Smith & Jones" becoming on incorporation "Smith & Jones Company." This practice is very common in all the states, whether required by law or otherwise, and is generally preferable to the use of the unmodi- fied firm name, or its use in connection with the word "Incor- porated." In New York and a few other states, the word "Incorporated," its abbreviation "Inc.," or other words indicat- ing incorporation must be used in the name to distinguish clearly Ch. 59] INCORPORATING A PARTNERSHIP 499 the corporation from an individual or partnership business, and the word " Company" cannot be used. Another common modification of the firm name is to sub- stitute a hyphen for the connecting word and add " Company "- "Smith & Jones" then becoming the "Smith- Jones Company." In most of the states the prefix "The" either may or may not be made part of the corporate name, though in a few states its use is obligatory. Owing to the additional length given the corporate name by its use, and its exceeding awkwardness in certain legal constructions, the word "The" is better omitted unless there are special reasons for its retention. f * rj 542. Capitalization If after incorporation the partnership business is to go on under the corporate form with only the former partners inter- ested, no stock being sold to outsiders, the simplest and possibly most satisfactory basis of capitalization is the actual value of the assets turned into the new corporation, without allowance for good-will, trade-name, or any other intangible assets. Then, on incorporation each partner will participate in the stock by which this capitalization is represented, dollar for dollar, to the amount of his existing partnership investment. Under this plan the capital stock of the new company is kept at a comparatively low figure, taxation is to some extent avoided, while the respective proportionate interests of the different partners are accurately preserved. As will be readily seen, no very exact estimate of the value of the business is nec- essary under this arrangement. The capital stock merely serves as a convenient method of adjusting the proportionate interests of the partners, and, no matter what its amount, these interests are still represented in proper proportion. If, however, new members are to be taken into the incor- porated business, or any of the partners expect to sell stock, or it is anticipated that at any time in the near future stock will change hands, the proper valuation and capitalization of the 500 CORPORATE LAW [Bk. I- business become matters of great importance. Then the value of the good-will should be added to the property values; also any other intangible assets, such as trade-names, trade-marks, and copyrights, should be included at a fair figure. All of these are valuable assets and are legitimately represented in the capitalization of the business. Contemplated profits are not a proper basis for capitalization^ but a valuation of a plant based upon the earnings for the previous year, capitalized at 6% interest, has been held proper." . Any desired property may, of course, be reserved to the partnership. If th z - <3 O - SAl"" 1 " ' talizatioiv will naturally be reduced by just that amount. ftT^ - 2b ^\ (^ < preferred stock is issued, the common stock will be reduced^ 3 by that amount, but the total capitalization will remain]?^ the same. In the incorporation of a partnership, no-par-value stock may at times be used to great advantage. Thus preferred stock may be used to give the actual investors of capital proper com- pensation for the use of their money, and no-par-value stock be used to represent their contingent interest, or to represent their equal or proportionate interest in profits. Other methods of using this modern device will suggest themselves. 4 If additional capital is needed for the business of the new corporation and stock must be sold to secure it, the amount of capitalization determined by the total value of the partnership * See v. Heppenheimer, 69 N. J. Eq. 36 (1905). Railway Review v. G. D. & M. Tool Co., 84 N. J. Eq. 321 (1914). * See Chs. XIV, XV, and XVI, treating of no-par-value stock and its use. Ch. 59] INCORPORATING A PARTNERSHIP 501 assets including good-will would naturally be increased by the amount of stock to be sold. 543. Incorporation and the Income Tax It is necessary to consider carefully what effect incorporation is likely to have on the taxes to be paid the federal government. The excess profits tax in former years at times penalized the corporate form, and in its amended form still discriminates be- tween partnerships and corporations. Of the excess profits tax and its effects in this direction, David F. Houston, ex-Secretary of the Treasury, says: This tax attaches to business transacted only on the one form'* jj; of organization the corporate form. It applies only to corpora- tions and gets its name from the fact that the law exempts corporate incomes equal to 8 per cent of the invested capital plus $3,000. The net income above these deductions and not in excess of 20 per cent of the invested capital is taxed 20 per cent and the net income over and above this is taxed 40 per cent. Such is the excess profits tax. The corporation also pays a normal income tax of 10 per cent and its stockholders pay supertaxes on its distributed profits. Businesses not conducted on corporate form, but com- petitive in many cases with corporations, such as sole proprietors and partnerships, which are more numerous than corporations, do not pay the excess profits tax. They pay the normal income taxes and surtaxes on their entire profits, whether distributed' or undistributed. The excess profits tax was intended to be an equivalent for the surtax levied upon the undistributed or re- invested profits of sole proprietors and partnerships. But in reality it does not work out this way. It has proved to be inequitable as between corporations and other forms of business. In 1918 members of a well-known partnership paid nearly $1,125,000 more in taxes than they would have paid as a corpora- tion, and all their competitors were corporations. As a rule, however, corporations pay a heavier tax. In 1917^ . t. partner in a small business entered the government service, and for convenience, the business was incorporated. It paid nearly 4^ times as much on its earnings in 1918 as it would have paid if it had not been incorporated. This tax also works inequitably as among corporations. A conservatively managed corporation is CORPORATE LAW [Bk. I- penalized. If, however, it is generously capitalized, its exemption based on the 8 per cent of its capital will be large and it may escape with little or no excess profits. The tax is complex and difficult of administration. In any particular case, it would not be safe to incorporate without taking expert advice in regard to the effect on taxations of the proposed capitalization.^ 544. Exchange of Property for Stock The value of the partnership business and property having been determined, and the capitalization of the corporation fixed at this total value, the business as a going concern will be offered to the new corporation in exchange and full payment for all its capital stock. This offer should be by formal written proposi- tion, usually signed by one of the partners with the firm name, but sometimes signed by all the partners. This proposition is usually accepted without demur, the new corporation authorizing the issue of its capital stock in payment for the property. The capital stock will then be issued in accordance with the terms of the proposition, and the partner- ship business and property as tendered will be transferred to the corporation, usually by formal bill of sale, though sometimes by mere delivery of possession. The partnership books of account will be closed by proper entries showing the transfer to the corporation, and proper corporate books will be opened. This completes the transaction as between the partnership and the corporation. The corporation then owns the business as transferred to it, but the partnership still exists with the stock as its sole asset, unless some of the partnership property has been reserved from the sale to the corporation. The distribution of this stock among the partners in accordance with previous agreements, or usually in proportion to their respective firm interests, completes the 1 To appreciate the intricacy of the problem, the reader should study an article on this subject in Administration for October, 1921, by H. H. Baily of the University of Illinois. Ch. 59] INCORPORATING A PARTNERSHIP usefulness of the partnership. It may then be continued in a quiescent condition, be dissolved by formal agreement, or merely be allowed to lapse. If no partnership property was reserved and the stock received by the firm is distributed, and there are no special reasons for its continuation, dissolution by formal agreement is the better practice, avoiding any possibility of subsequent entanglements or liabilities. If it is desired to avoid any possibility of future liability under the old firm, formal notice should be given, by mail or publication, of the incorpora- tion of the business and the dissolution of the partnership. 545. Stock Adjustments In an ordinary partnership, when the investments are equal or nearly so, the stock received in exchange for the partnership property is usually all common stock, with or without par value, and is distributed among the partners in proportion to their respective investments in the old partnership. If, however, special conditions are to be met, this arrangement may be varied almost indefinitely. At times preferred stock is desired by the partners to repre- sent a portion, at least, of the property transferred by them to the corporation. Such stock has the advantage of its fixed preferential dividend that must be paid if any profits are made, and, so far as permitted by the state laws, it may be given any other powers or privileges deemed necessary. At other times the partners will perhaps prefer to have a portion of the payment for property transferred to the corpora- tion in the form of bonds. Corporate taxation is usually thereby avoided, though personal taxation may be proportionately increased. Beyond this, bonds are a safe and very convenient form of corporate security to hold if the incorporated business is, in whole or in part, going into new hands. By the use of common stock, with or without par value, preferred stock of varying powers and privileges, and bonds, almost any requirements of a partnership to be incorporated CORPORATE LAW [Bk. I- may be satisfactorily met. For instance, a silent partner's interest might be properly provided for by a preferred stock, drawing a preferential dividend equal to the rate of interest theretofore paid upon this partner's investment, or participating otherwise in profits to the same extent as the investment did before. This preferred stock might be allowed to vote, or if it were not desirable that the silent partner should participate in the management, the voting right might be denied, or his entire interest might be provided for by an issue of bonds which would draw a fixed interest without regard to profits, but could not vote. Or if one partner's investment were much larger than that of other partners', but equality in management were desired in the new corporation, the excess interest of the one partner might be provided for by non- voting preferred stock, by a bond issue, or perhaps by an issue of common stock without the voting right. In the latter case such partner would participate in all profits on the basis of the full amount of stock held by him, but would not vote on the excess portion. If his excess investment were in bonds, he would vote and participate in dividends on the basis of the amount of stock actually received by him, but would receive in addition the fixed amount of interest called for by his bonds. Also, at some specified date he would receive payment of the face of his bonds, his excess investment under these conditions constituting a preferred claim against the cor- porate property. Under the preferred stock plan, he would participate in profits to the full on his quota of common or no- paj-value stock, but on this preferred stock would, as usually arranged, participate in profits only to the extent of his preferred dividend. The final redemption of such preferred stock might or might not, according to the arrangement, take precedence over any liquidation of the common stock or no-par-value stock. 546. Board of Directors If the partners take the amount of stock in the new corpora- tion to which their respective partnership interests entitle them, Ch. 59] INCORPORATING A PARTNERSHIP 505 a.nd let the selection of the board take its natural course there- after, the matter is simple. Usually, however, the partners wish an equality of power in the board, or a specified representation, or a classification, or some other special arrangement, and the composition and method of electing the board of directors fre- quently becomes the most difficult question arising in the incor- poration of a partnership. Where equality of power is desired, each partner will usually designate one or more directors, so that the completed board will contain an equal number of representatives for each partner. Where the partnership consists of three or more, the usual practice is to make the number of directors equal to the number of partners, elect all the partners, or the chosen representatives of any partners not wishing to appear on the board, and then make provision for the maintenance of the board so constituted. Where there are two partners the matter is less easily ar- ranged. Three is the minimum number of directors usually allowed, and the necessity of having a third director who really has the deciding vote in any point of difference makes the situa- tion difficult. Sometimes a confidential clerk, or a mutual friend, or the wife of one of the partners is chosen, but in event of any difference the result is apt to be very unsatisfactory. If possible, a mutual friend of character and standing may be elected, with the understanding that he is not to be involved or troubled in any way unless serious differences arise, when he will virtually act as an arbitrator. Another plan is to have some indifferent person accept the office and immediately resign, leaving the third position vacant with the two partners in con- trol to fight out any differences, just as they would have done in the days of the partnership. If this plan were objectionable on account of the incomplete condition of the board, the mem- bership of the directorate might be fixed at four, each partner being elected to the board and designating an additional member. In such case it may be wise to provide for arbitration in case of a deadlock. 506 CORPORATE LAW [Bk. I- 547. Maintenance of Agreed Management When the composition and manner of election of the board of directors has once been decided, some means of securing the permanency of the agreed arrangement is usually desirable. If mere representation of the minority interest on the board is desired, this may usually be secured by the adoption of cumula- tive voting. In some states, however, cumulative voting is not permissible and in many cases more than minority representa- tion is desired. Other means must then be adopted. Some of these are as follows: i. BY VOTING TRUST. The voting trust is often the most satisfactory means of preserving the agreed status of corporate management, the members of the old partnership usually con- stituting the membership of the trust. The objections to the voting trust for such a purpose are its limited duration, and the fact that the stock owned by the part- ners is itself locked up in the trust and, for purposes of sale or other use, must be represented by trustees' certificates instead of the usual stock certificates. In New York and Maryland the life of a voting trust is by statute expressly limited to five years, and it is doubtful whether the arrangement could be enforced or continued, save by mutual consent, for a longer period. In states where there is no legis- lative provision in regard to the voting trust, it is probable that a trust for the purpose of maintaining an agreed management would be sustained for any reasonable period, as ten or even more years. In case of the formation of a voting trust, the actual assign- ment of the stock to the trustees cannot be avoided, as irre- vocable proxies would be practically impossible under the usual conditions. The owners of the stock must therefore content themselves with trustees' certificates. For holding and for some other purposes these certificates would not be objec- tionable. For selling or for use as collateral they would not be so available as the stock itself. Ch. 59] INCORPORATING A PARTNERSHIP 507 2. BY VOTING REQUIREMENTS. In most states where special charter provisions are allowed, it may be provided that any desired majority shall be necessary for the election of direc- tors, and this majority may be made so large even up to the unanimous vote of all the outstanding voting stock that the agreed status of the board can be disturbed only by the active consent of all interested parties. Deadlocks may occur at times under such a provision, but their only effect would be to leave the board in statu quo, thus maintaining the agreed arrangement but dispensing with the election. It would be but rarely advisable or wise to require unanimous consent to the election of directors. The same ends may be practically secured by a two-thirds or three-fourths majority, and the danger of factious opposition by holders of a small number of shares is thereby avoided. It is to be noted that under this arrangement, in event of the death or resignation of a director, the interests for which such director stood would not be represented on the board and could regain such representation only by consent of sufficient stock to make up an electing majority. This objection to the plan is under some conditions fatal. 3. BY CLASSIFICATION OF STOCK. The classification of stock offers a very permanent method of maintaining a representative directorate. Each partner's stock may be constituted a class with some convenient arbitrary designation, as "Class A," " Class B," or "Class i," "Class 2," etc., and each one of these classes be endowed with the right to elect one or more directors. If desired, one class may be allotted a greater number of directors than others, though usually each class is allowed equal power as to the election of directors. For instance, in the incorporation of a partnership with property and other assets of the estimated value of $100,000, of which $50,000 belongs to one partner, $30,000 to a second, and $20,000 to a third, it might be desired that the same equal participation in the management that characterized the partner- 508 CORPORATE LAW (Bk. I- ship should be continued in the corporation. This might be effected with absolute certainty by capitalizing at the esti- mated value and dividing this stock into three classes, $50,000 in the first, $30,000 in the second, and $20,000 in the third; giving to each class the right to elect one-third of the membership of the board, and issuing to each partner the class of stock which represents his partnership interests. Then, notwithstanding their very unequal interests in the business, each would elect one-third the total number of directors. If it were not desired to secure this absolute equality in the management of the business but merely to insure representation to the two minority partners, this stock might be classified as before on any appor- tionment deemed expedient, the first class being given, say, three directors of a board of five, and the second and third classes, one each. Under this system the interests holding any one class are absolutely sure that, so long as they hold their stock intact, or hold a clear majority of i/,they can elect their allotted member- ship of the board, and that in no other way than by the purchase of at least a majority of their stock can this representation be wrested from them. It is obvious that the plan is capable of considerable variation to fit special cases. A modification of this plan where equal representation is desired, is to divide the voting stock of the corporation equally among the partners, and then issue preferred stock without the voting power to cover the excess investment of any particular partner. Also, where more capital is desired, such non-voting preferred stock may be sold without interfering with the original division of power. 6 548. Officers In the conversion of a partnership into a corporation, little difficulty is experienced in the selection of officers, as the partners usually take these positions; their previous habits, duties, and *See {{ 221. 534. Ch. 59] INCORPORATING A PARTNERSHIP 509 positions in the firm designating with more or less precision the official position for which each is best fitted. It may be noted, however, if there is difficulty in the assign- ment of the official positions, that outside of a few matters specified or implied by the statutes of some states, the powers and duties of officers may be fixed absolutely by charter or by-laws. The power of the president may be restricted in any way the conditions seem to demand, any desired limita- tions may be placed upon the power of the treasurer, the secretary may be assigned any powers or duties within or without the usual range, and any or all of these officers may be made as dependent upon, or as independent of, the board and of their fellow officers as may be deemed expedient. Usually it is not the part of wisdom to vary the customary powers and relations of the corporate officers, but occasionally in the adjustment of partnership relations under the corporate form such changes may be made to advantage. CHAPTER LX THE MANAGEMENT OF CLOSE CORPORATIONS 549. Close Corporations and Their Conduct As a rule, when partnerships are incorporated all the stock is issued to, and held by, the former partners, who are also officers and directors of the new corporation. The corporation is then owned by, and in fact composed of, these few persons. Such a corporation in which all the stock is held by a few per- sons who are also officers and directors of the corporation, is a typical "close" corporation. The conduct of a close corporation can be, and usually is, more informal than that of the ordinary corporation with a number of stockholders. Especially is this the case with incor- porated partnerships where the members of the new corporation are friends and associates of long standing and are accustomed to working together. 1 The business of a close corporation of this nature is conducted with the same informality as that of an ordinary partnership. The directors and officers are chosen at the time of organization , and it is usually understood that this organization is to be per- manent. If owing to death or withdrawal a vacancy occurs, a special meeting of the board is very easily called to elect a suc- cessor. The various duties are assigned to the different officers on the basis of their duties under the partnership. About some matters all will confer; other matters will be decided by special officers who have them particularly in hand. Frequently some one man dominates everything and directs the business just as he did before in the partnership. See preceding chapter, "Incorporating a Partnership." 510 Ch. 60] CLOSE CORPORATIONS 511 550. The Apportionment of Profits The profits of a close corporation may be apportioned with the same absence of formality. Usually by agreement certain salaries are attached to the various official positions, and most of the profits are taken out in this manner. As the amount paid in salaries diminishes by that much the income of the corpora- tion and thus avoids the payment of state and federal income taxes, there is in every close corporation a strong temptation to raise the salaries of the principal officers to the maximum figure. As the profits of a close corporation are usually largely the re- turns for personal ability and business skill, there is often good ground for the payment of. liberal salaries. The tax officials will, however, properly interfere if the salaries exceed fair payment for the services rendered and are obviously being used to evade the payment of taxes. At some future time it is likely that there may be more definite rules on this subject than exist at present. Now it is hard to decide in each case what is legally and ethically justifiable. From the practical standpoint, the free and easy conduct of the ordinary close corporation is not open to serious criticism. Nor, so long as all goes well and no stockholder objects, and no creditors remain unpaid, is there any legal objection. 55 1 ' Judicial. Approval of Informal Management How far the courts sustain this informal conduct oi close corporations is shown by the following cases: In Hall v. Herter Brothers, 2 a partnership had incorporated with five incorporators, consisting of the two partners, the father of one partner, the brother of the other, and a salesman who had been with the partnership for some time a typical close corporation. Judge Alton B. Parker, in discussing the very informal procedure of the corporation, said: "Now, when there are so few interested in the management of a, corporation, ordinary business may be transacted without the formality of 1 83 Hun (N. Y.) 19. 22 (1894) 512 CORPORATE LAW x [Bk. I- resolutions. It may be done by conversation without formal votes." In the Massachusetts case of Melledge v. Boston' lion Com- pany, 3 the court said : "Where a corporation consists of a small number of persons, like a partnership, they may transact all their business by conversation without formal votes." In Little v. Garrabrant, 4 a corporation consisted of Richard Worthington holding 10 shares, his wife holding 139 shares, her housekeeper holding 50 shares, and a nephew holding i share. "From the beginning to the end all of the family expenses, rent, fire insurance, taxes, together with their contributions to charity and church and missionary societies, were paid out of moneys of the Worthington Company by checks drawn against its account in the bank or from the proceeds of checks thus drawn." Nevertheless the court held that there was no illegality in this exceedingly loose method of doing business, and that creditors who became such after the time of this distribution could not complain. Creditors who were such at the time might have objected to the very irregular disbursement of the corporate funds, but creditors who became such later could not. In the case of Groh Sons v. Groh, 5 where a brewery owned by the Groh family had become incorporated, the court said: As between the owners and holders of all the stock of a corpora- tion, it must in principle follow that the members of such corpora- tion entitled to receive dividends may agree among themselves, either by conversation or otherwise, to appropriate of the funds of the corporation a specified sum, as agreed upon, and distribute the same, and the stockholders, upon receipt of it, will acquire good title thereto as against the other members of the corporation. It amounts to a mere division of the property by agreement of all the parties in interest, and as between them it is perfectly good and may not be attacked where the act does not impair the rights of third parties. * 5 Cush. 158, '179 (1849). 90 Hun (N. Y.) 404; affd., IS3 N. Y. 661 (1897). 6 80 App. Div. (N. Y.) 85 (1903); see also Eureka Iron Works v. Bresnahan, 60 Mich. 332 (1886); Lemars Shoe Store Co. v. Manufacturing Co., 89 III. App. 245 (1899). Ch, 60] CLOSE CORPORATIONS 513 The decision in this case was afterward reversed; not, how- ever, because of this very informal method of declaring divi- dends, but on other grounds. 552. Minimum Number of Stockholders in a Corporation In the consideration of close corporations, the minimum num- ber of stockholders required to form a legal corporation is a matter of importance. The minimum of incorporators in most of the states is three and this fixes the original number of stock- holders, but there is usually no statutory requirement that this number of stockholders shall be maintained. It is but seldom that a corporation has less than three stockholders, but there is no legal objection to one person owning all the stock of a cor- poration, save in those states where directors must be stock- holders. There would, however, be practical difficulties in the conduct of a corporation with but one stockholder, and in any such case it would be expedient to put at least the nominal ownership of one or more shares of the stock in the names of other parties. This would qualify these others for board posi- tions and would also enable them to assist in holding meetings. In England it has been held that one stockholder cannot con- duct a meeting by himself, but in this country the reverse has been held. 6 In most of the states three directors are prescribed by the statutes, and if the directors must also be stockholders, this in itself necessitates at least three stockholders. It is always possible to comply with any legal or practical requirements for additional stockholders by placing the nominal or actual owner- ship of one or more shares of stock in the names of suitable parties. 553- Restricting the Sale of Stock The stock of a close corporation is usually not for sale. On the other hand, a stranger would not usually desire to buy Sharp v. Dawes, 2 0- B. Div. 26 (1876); In re Sanitary Carbon Co., 12 W. N. 223 (1877); contra, Morrill v. Little Falls Mfg. Co., S3 Minn. 371 (1893). 5T4 CORPORATE LAW [Bk. I- stock in a close corporation, as the stockholders in control, if they were disposed to resent the intrusion of the newcomer, could combine in many ways to make his holding unsatisfactory. To make assurance doubly sure, however, special arrangements are often made to prevent the sale of stock in close corporations to strangers. 7 The most common method of attempting this is the passage of a by-law prohibiting the sale of stock to anyone not already a stockholder, or prohibiting the sale of stock unless with the consent of the directors, or unless it has first been offered to the directors at a price not greater than that at which it is subse- quently offered or sold to outsiders. Such by-law provisions are usually illegal and incapable of enforcement, as the policy of the law is opposed to any restrictions upon the free transfer of stock. If a stockholder, in defiance of the terms of such a by-law, should sell his stock, the purchaser could force the cor- poration to recognize him as a stockholder and to issue him certificates in his own name. If, however, any such restriction were printed on the stock certificate, it would, regardless of its legal force, make the stock extremely difficult to sell and would thus indirectly accomplish the desired end. Few people care to purchase rights which may require tedious and expensive process of law for their en- forcement. In one case a by-law was framed providing that no transfer would be recognized by the corporation unless the written con- sent thereto of the three directors of the corporation was in- dorsed on the certificate. This by-law was embodied in the cer- tificate, and a blank form of directors' consent was printed on the back with places for the signatures of the three directors. In practice this effectually prevented the sale of the stock; but if anyone had in defiance of the provision purchased the stock without the consent of the directors, he could have forced the corporation to recognize his rights as a stockholder. ' See Book II, 56. Jlj. 60] CLOSE CORPORATIONS 515 Stockholders may, however, mutually agree to give each other an option to purchase their stock at a specified price, or at an appraised price, or at a price not greater than that at which it afterwards might be sold. In any such case the con- tract is legal as between the stockholders; but if in violation of his agreement a stockholder sold his stock, the purchaser would "take it unaffected by this fact. The seller might be held liable in damages to the other parties but the sale would stand. In a New York case four parties, wishing to perpetuate the successful management of a valuable business, agreed that in event of the death of any of the parties, or in event of any party wishing to sell, the other parties should have a thirty-day option on his stock at $125 per share. When one of the parties died, his executor refused to carry out the contract. Suit was brought to compel specific performance and the contract was upheld. 8 There is a line of cases in Massachusetts and New Hampshire in which by-laws restricting the alienation of stock have been sustained as between the parties to the contract i.e., the stock- holders who purchased stock knowing of and agreeing to the by-law restrictions on the general ground that, while such a by-law might be contrary to public policy as it applied to the rights of outsiders, it was valid as a contract between the stockholders. 9 Scruggs v. Cotterill, 67 A. D. (N. Y.) 583 (1902); Costello v. Brewing Co., 69 N. H. 405 (1898). Trust Co. v. Abbott, 162 Mass. 148 (1894). This case is discussed in 27 L. R. A. 271; Blue Mt., etc., Assn. v. Borrow, 71 N. H. 69 (1901). 'ivrti-vreat ^rft ^ftl ,,. ,, fm f :.. CHAPTER LXI CONSOLIDATION, REORGANIZATION AND DISSOLUTION' 554. Forms of Consolidation The methods by which corporations may be practically uni- fied are as follows: 1. Consolidation of one or more corporations by statutory procedure. 2. Purchase by a corporation of the entire assets of one or more other corporations. 3. Lease by a corporation of the entire property of one or more other corporations, usually for a specified amount or a guaranteed dividend. 4. Purchase by a corporation of a stock control in one or more other corporations. 5. Combination, usually by means of a holding company. 2 The terms consolidation, combination, merger, and amalga- mation are loosely applied to any of the foregoing plans for joining the interests of two or more corporations. Strictly speaking, a consolidation is the combination or merging, by procedure prescribed by the statutes, of two or more corpora- tions into a single new organization embracing the respective interests and property of the merged corporations. 3 Such con- solidation without statutory authority is ultra vires, i.e., beyond the corporate powers, and hence void, unless authorized by unanimous vote of all the stockholders. ' See Book II, Ch. XVIII, "Combinations," Ch. XL, "Reorganizations"; also Book III, Part VI, "Reorganization, Receivership and Dissolution." 1 Noyes' Intercorporate Relations, I. Green's Brice's Ultra Vires (and Edition), 631. 516 Ch. 61] CONSOLIDATION AND DISSOLUTION 517 In any case where it is desired to unify corporate businesses, careful study of all the circumstances and local statutes should be made before deciding on the method to be followed, in order on the one hand to avoid violation of existing law, and on the other, hand to secure the most effective possible combination. The assistance of skilled counsel is always necessary to accom- plish this. 555. Statutory Consolidation In nearly all the states laws are provided for the consolida- tion of non-competing railroads. Not so many have statutes authorizing consolidation of business corporations. Such stat- utes, when they exist, are usually made to apply only to cor- porations engaged in the same or similar business. Under such provisions a gas company and an electric light company have been held competent to consolidate. Where there are statutes providing for consolidation, it is usually specified that a majority or two-thirds or three-fourths of the stockholders of each railroad must vote in favor of such action; and in many of the states dissenting stockholders may require the corporation to purchase their stock at an appraised valuation. If there is no statutory form for consolidation, it may, unless in some way prohibited, always be authorized by the unanimous vote of all the stockholders. The usual procedure for statutory consolidation is as follows : 1. Agreement as to terms by directors of the consolidating corporations. 2. Submission of directors' agreement to the stockholders of each company at a duly assembled meeting. 3. Assent of the stockholders to the directors' agreement by a required vote. 4. Filing of certified copies of the agreement and the vote in its favor in the same offices in which the original certificate of incorporation of each of the consolidated corporations was filed. 518 CORPORATE LAW [Bk. I- Ordinary business corporations rarely combine under the statutory provisions, as it is usually simpler to unite by some other method. 556. Consolidation by Purchase of Assets When all the stockholders consent, a business corporation as distinguished from a public utilities corporation may sell its entire assets for the stock of another corporation. The first corporation may then dissolve and divide its assets which con- sist of the stock of the other corporation among its stockhold- ers. The purchasing corporation then continues both its own business and the business of the dissolved corporation, the stockholders of the defunct corporation now holding their pro- portionate interest in the operating corporation. This is the simplest and best method of effecting a consolida- tion. The only obstacle to its use is found in the fact that one dissenting stockholder can interpose and prevent the consum- mation of the plan. In such case it is often possible to buy out any dissenters and carry out the consolidation as proposed. A public utilities corporation having a franchise derived from the public is not free to sell it at pleasure. In such cases con- solidation must be effected in some other way. 557- Consolidation by Lease of Property A lease of the entire property of a prosperous corporation may be made only by unanimous consent of all its stockholders, and consolidation by means of a lease contract is therefore available only where consolidation could be effected by sale of the corporate assets as already discussed. A corporation that is in a failing condition may, however, lease its property by action of its directors, or of a majority of its stockholders when such lease is for the best interests of the creditors and stockholders, 4 and in this case a practical consoli- dation by means of a lease is possible. 4 Skinner v. Smith, 134 N. Y. 240 (1892); Bartholomew v. Derby Rubber Co., 69 Conn. 521 (1897). Ch. 6i] CONSOLIDATION AND DISSOLUTION 519 In many cases railroads are empowered to lease their prop- erties, and such action may be authorized by majority vote of the stockholders. A practical consolidation by means of a lease is then possible. 5 Where a valid lease of a corporation's entire property is made, the lessor corporation's only active business operations are then the reception of its rentals and the apportionment of these among its stockholders as dividends. In some cases property is leased on the basis of a guaranty of a certain dividend on the stock of the lessor corporation. 558. Consolidation by Purchase of Controlling Interest When it is desired to unify the operations of two or more corporations, it may be done by the common ownership of a controlling interest in each corporation. This controlling inter- est may be in the hands of an individual, a syndicate, or a hold- ing corporation. The approved form is by means of a holding corporation, formed under the laws of New Jersey, New York, Maine, Dela- ware, or some other state where corporations are empowered to hold the stock of other corporations. This "holding company" buys up a majority of the stock of the companies which it is desired to unite. At the next annual elections of these controlled corporations boards of dummy directors are elected, who man- age the different combined corporations along common and non-conflicting lines in accordance with the instructions of the holding corporation. 6 The plan was for a time a very effective method of forming a trust. 7 559- Combinations This is a very general term embracing pooling agreements, trusts, the different forms of holding companies, and general 1 Dady v. Georgia, etc., Ry., 112 Fed. 838 (1900). See Ch. LVII, "Holding Companies." 7 For present status, see { 526. 520 CORPORATE LAW [Bk. I- associations to prevent competition, maintain prices, and limit production. The original plan of a board of trustees holding controlling interests in the corporations to be combined was held illegal. 8 Partnership agreements between corporations have like- wise been held illegal. The federal statutes and the statutes of almost every state prohibit and provide for punishment of combinations in restraint of trade or for purposes of preventing competition. It is diffi- cult or impossible at the present time to form any legal com- bination to regulate prices. 560. Trade Associations Since it has become legally impossible to form any sort of a combination to maintain prices or limit competition, many lines of business have united in trade associations. These associations are based on the theory that: Knowledge regarding bids and prices actually made is all that is necessary to keep prices at reasonably stable and normal levels. 9 Their operation is thus described : In order that they might know as definitely as possible what the supply and demand of the market would be, they decided to have their secretary compile, at regular intervals, statistics that would show exactly how the market stood. The members severally agreed to furnish to the secretary confidentially the information about production, orders, and shipments that was necessary in order to compose these reports. The secretary was not to make public the private information received from members but was to issue all statistics in summaries. 10 There are, it is said, over 1,000 of these associations in operation to-day. So long as they confine their activities to merely keeping their members informed as to trade conditions and happenings, they violate no law, but in some cases it is 'State v. Standard Oil, 49 Ohio 137 (1892); People v. North River Sugar Refining Co., 121 N. Y. 582 (1890). ' The New Competition, by Arthur Jerome Eddy (1913), p. 126. 10 Trade Associations, by Emmett Hay Naylor (1921), p. 10. Ch. 61] CONSOLIDATION AND DISSOLUTION 521 probable they have gone beyond this and have laid themselves open to the charge of restraining competition and maintaining prices. Some form of trade association is inevitable and these associations doubtless have a future before them. Since the foregoing was written, the United States Supreme Court has rendered a decision adverse to the open price com- petition plan of the American Hardwood Manufacturers' Asso- ciation. This is the first case that has come before the Supreme Court in which the legal questions as to the practices of organ- izations known as "open price associations" have been consid- ered. [In it the Supreme Court sustained the permanent injunc- tion granted by the lower courts restraining 329 hardwood manufacturers from compiling, exchanging, and discussing prices, production, stocks, and market conditions. The court in its decision held that the plan "constituted a joint conspiracy to restrict lumber production in the country and keep prices up." The decision seems to be far-reaching and will probably make it absolutely impossible for industrial groups to study their economical problems, and pool their information through market letters. It is probable that all of the trade associations in the country at the present tune are doing things condemned by this decision. It is to be noted that in this case both Justice Brandeis and Justice Holmes delivered carefully written dissenting opinions. Justice Holmes stated that in his opinion the decision prohibited the distribution of information as to stocks, production, or the discussion of prices, and even the exchange of opinions as to prices in the future. It would seem that the decision was un- fortunate in that it places the smaller manufacturers and pro- ducers at a disadvantage as compared with their larger rivals. In the case of the United States Steel Corporation the courts were of the opinion that it was not unlawful to vest in a single corporation the control of 50% of the steel industry of the country, but now it is held that the smaller steel corporations which exchange statistical information to equalize their com- 522 CORPORATE LAW [Bk. I- petitive disadvantage are doing that which is illegal. This would seem directly to encourage the formation of large corporate combinations. 561. A Possible Solution It would seem possible for experts in each line, possibly the officers of existing trade associations, to form their own indi- vidually conducted bureaus of information,, to collect and dis- tr bute trade information along particular lines to those willing to pay them for their services. Such bureaus of information exist in many directions already, and it would not seem that there could be any legal objection to such an arrangement. In so far as trade associations are operated to collect and dissemi- nate trade information, to record past transactions and give accounts of the trend of trade activities in various parts of the country, these private bureaus could probably take their place. !mr, ^rrirfofi-} 562. Reorganization Reorganization is generally employed as a means of rehabili- tating a corporation that has failed or become financially em- barrassed or entangled, when its name, property, franchises, trade-marks, or good-will are still worth saving. The term is loosely applied to various forms of consolidation, new incorpora- tions, and similar arrangements. Reorganization is not uncommon 'in the case of railroads and other public service corporations. The franchises of these cor- porations must usually be operated or they are lost, and stock- holders and creditors are as a rule better satisfied to have the corporation continue in some reorganized form under which they still have an interest or recognized claim, even though reduced, than to permit the corporate assets to be sold for the inade- quate prices of a forced sale, or the franchise to lapse for non- user. Reorganization is also not infrequent in the case of insolvent or embarrassed business corporations when the creditors consent Ch. 6ii CONSOLIDATION AND DISSOLUTION 523 * to some adjustment or arrangement of their claims that will permit the corporate business to continue. The reorganization in such case may be limited to a mere issue of additional stock or bonds, or may extend so far as to be in effect a new in- corporation. If such reorganization is not possible and the business of the embarrassed corporation is of sufficient value, the usual plan pursued is for all or the principal stockholders of the old cor- poration to form a new and entirely distinct corporation. The property and business of the embarrassed corporation are then allowed to go to forced sale and are bought in as nearly in their entirety as possible by the new corporation. This latter then takes a clear title to these assets and conducts the business thereafter free from all claims of creditors or stockholders of the old corporation. A similar procedure is sometimes improp- erly employed in order to "freeze out" small or objectionable stockholders the corporation being deliberately involved or allowed to be involved for the purpose. 563. Dissolution A corporation may be dissolved by the expiration of the term for which the charter was granted. This does not, how- ever, often happen. If the corporation is active and prosperous, some form of reorganization or extension of the corporate exis- tence is effected before the expiration of its charter period. If it is not profitable, it is usually dissolved or allowed to lapse long before its charter term expires. A corporation may also be dissolved by insolvency. In such case a receiver may be appointed to dispose of its assets and divide the proceeds among its creditors, or the corporation may be allowed to go into bankruptcy and its affairs be wound up by a trustee. Even though a corporation is insolvent, it may be rescued from dissolution by an abatement of the creditors' claims, or by the contribution of additional capital by stock- holders or others. 524 CORPORATE LAW [Bk. I- A corporation may always be dissolved and its affairs be wound up by proper procedure if all its stockholders consent. In many states a majority of the stockholders and in some states less than a majority may dissolve the corporation under some circumstances by prescribed statutory procedure. Corporations destitute of assets are sometimes practically dissolved, or allowed to lapse by simply ceasing to transact business. Such corporations are not technically out of existence and in some cases their officers are still subject to liabilities. The procedure is, however, easy and inexpensive and many corporations end in this manner regardless of the possible lia- bilities of their officials. Part XIII Allied Forms of Organization CHAPTER LXII JOINT-STOCK COMPANIES AND PARTNERSHIP ASSOCIATIONS 564. Joint-Stock Companies In the United States an unincorporated joint-stock company with its capital divided into transferable shares may be formed in the same manner as an ordinary partnership, merely by agreement of the parties. Except in the state of New York, no license is necessary, no public registry is prescribed, nor are formalities of any kind required. Such an association may issue transferable certificates of stock, and may provide against ter- mination by reason of the death, withdrawal, or insolvency of one or more of its members. The association may designate agents to attend to its business and then only these authorized agents can do business for it. The members cannot act for it and bind it as in an ordinary partnership. The members of such a common law joint-stock company are, however, subject to full partnership liability. 1 In New York any joint-stock association doing business in the state must, within 60 days after its formation, and thereafter in each January, file with the secretary of state and with the county clerk a written certificate giving its name, date of organ- 525 526 CORPORATE LAW [Bk. I- ization, number of stockholders, names and residences of its officers, and its place of business. The statutes empower it under certain circumstances to hold real property in the name of its president, and it may mortgage such real estate by the same procedure as is required of a corporation. These organizations have come up before the courts of New York from time to time and it has been repeatedly held that "a joint-stock company is a partnership with some of the powers of a corporation." 2 The Court of Appeals said of the National Express Company : The company was formed as a joint-stock company or associa- tion in 1853 by a written agreement of eight individuals with each other, the whole force and effect of which, in constituting and creating the organization, rested upon the common law rights of the individuals and their power to contract with each other. The relation they assumed was wholly the product of their mutual agreement, and dependent in no respect upon the grant or authority of the state. It was entered into under no statutory license or permission, neither accepting nor designed to accept any franchise from the sovereign, but founded wholly upon the individual rights of the associates to join their capital in an enterprise in a relation similar to that of a partnership. 3 i:j;r^i OD1 . 565. Disadvantages of the Form The joint-stock company form, while advantageous in many respects, is not extensively used, for the following reasons: 1. The members of the company are individually liable for its entire obligations. 2. While the company can do business under its company name, it cannot hold real property or convey the same by its collective name, the conditions requiring any deed or encum- brance of real property to be executed by every member of the company, unless such real property is taken and held by some agent or officer as trustee for the company, when conveyances or encumbrances must be executed by this trustee. 3. The joint-stock company must bring suit in the names of 2 Hibbs v. Brown, 190 N. Y. 167 (1907); Matter of Jones, 172 N. Y. 575 (1902). 3 People v. Coleman, 133 N. Y. 279 (1892). Ch. 62] JOINT-STOCK COMPANIES 527 the individuals composing it and, if it is sued, only those mem- bers who are served with process can be held. In New York it is provided that any joint-stock company or association may sue or be sued in the name of the president or treasurer, and individual members shall not be sued until exe- cution against the company has been returned unsatisfied. This provision seems to apply to all New York copartnerships of seven or more. It is not found in other states.* Several of the leading express companies of the country are organized as joint-stock companies and the arrangement seems to have worked well. These companies have been before the court many times and the cases will be found instructive. 5 566. When the Form Can Be Used The common law joint-stock company has advantages over the ordinary partnership that should commend it in some cases at least, and particularly where the publicity and liability to taxation of the corporate form are objectionable. In many businesses the danger of partnership liability is too remote to trouble the members, and in such cases the joint-stock organiza- tion secures the same transferability and divisibility of interests as does the corporation, and also avoids the interruption often caused by the death of a partner. The joint-stock company could not usually be employed where stock is to be sold to investors, as these would not risk the partnership liability involved. It could, however, be used in many cases as a sub- stitute for the close corporation. In such case the articles of association should be carefully prepared, as "The articles of association of an unincorporated joint-stock company bear the same relation to it that the charter bears to an incorporated company. They regulate the duties of the officers and the duties and obligations of the members of such a company among themselves." 6 4 Taft v. Ward, 106 Mass. 518 (1871). In the report of this case a full outline of the articles of association of the New England Express Co. is given. 6 Chapman v. Barney, 129 U. S. 677 (1888); Express Co. v. State, 55 O. St. 69 (1806). Bray v. Farwell, 81 N. Y. 600 (1880). 528 CORPORATE LAW [Bk. I- 567. Partnership Associations In Pennsylvania and Michigan the statutes provide for the organization of what are termed "partnership associations." These have nothing in common with the voluntary associations of Massachusetts. They differ from a corporation only in the following particulars: 1. Interests in a partnership association may be transferred as provided by the rules and regulations of each association in most cases, the association adopts the plan of stock certificates but in case of a transfer the transferee must be elected a mem- ber of the association before he can vote or participate in the management. If he is not elected, the interest already trans- ferred to him must be bought out at an agreed price, or in default of such an agreement an appraiser appointed by the court will appraise the same. 2. Originally no special fees or taxes were imposed upon these associations in the state where they were formed; but now in both Pennsylvania and Michigan organization fees similar to organization fees of corporations are prescribed. In Pennsylvania, when a partnership association is to be formed, a statement answering in a general way to a certificate of incorporation must be made by three or more persons and filed with the recorder of deeds for the county. The filing fees are nominal, but a bonus of ^3 of i% upon the amount of the capi- tal stock must be paid to the state treasurer. In Michigan partnership associations were first authorized in 1877, and the provisions were as simple as in Pennsylvania. In 1903 the legislature amended the law, and now the pro- cedure for the formation of a voluntary association is similar to that for the organization of a corporation. As stated by the statute, three or more persons desiring to secure limited lia- bility must sign and acknowledge a statement or articles of association giving their full names and the amount of capital subscribed by each; the total capital and when and where to Ch. 62] PARTNERSHIP ASSOCIATIONS 529 be paid; the character of the business; its location; the name of the association followed by the word "limited"; its duration, not exceeding 20 years; and the names of the officers. This statement is to be recorded in the offices of the secretary of state and of the county clerk and a fee of 1/20 of i% is to be paid on organization. Thereafter annual reports are to be made. In Michigan, for the protection of the minority, cumu- ative voting has been provided for in the election of managers. 568. Opinions of the Courts on Partnership Associations In Pennsylvania the court characterized associations of this nature as "quasi-corporations," stating that "technically they were not corporations but had many of the features of a cor- poration," and held that in ascertaining their legal status both the law of corporations and the law of partnerships should be resorted to according to the particular feature under con- sideration. 7 In Michigan partnership associations are governed by the law of corporations rather than by the law of limited partner- ships. 8 In a case in one of the federal courts it was held that they were in effect corporations. The court said: But these associations authorized by the Pennsylvania act of 1874 possess every attribute deemed essential to the existence of a corporation. . . . When organized, they constitute a new ar- tificial person, endowed with the power of suing and being sued, and of acquiring, holding and conveying property in its artificial character. Created by compliance with the constating law, they can be dissolved only in the way pointed out by that law. In- dividual liability for corporate debts, beyond unpaid subscription to the capital stock, does not exist. 9 This decision was later overruled by the Supreme Court of ' Carter v. Producers' Oil Co., 182 Pa. St. SSL 563 (1897). "Rouse, etc., Co. v. Detroit, etc., Co., in Mich. 251 (1896)- s. c., 38 L. R. A. 794; Wood v. Sloman, 150 Mich. 177 (1907); Armstrong v. Stearns, 156 Mich. 597 (1009). Andrews Bros. v. Voungctown Coke Co., Ltd., 86 Fed. 585, S9O (1898). 530 CORPORATE LAW [Bk. I- the United States, which refused to consider a partnership association under Pennsylvania laws as being anything more than a joint-stock company. 10 In Massachusetts also, the Supreme Court refused to treat these partnership associations otherwise than as ordinary joint-stock companies and held that a Pennsylvania partnership association could not be sued under its associate name in the courts of Massachusetts, and approved the doctrine that "at common law a joint-stock company formed for business pur- poses, is considered in this commonwealth merely as a partner- ship. "11 Partnership associations may be useful in the respective states which provide for their formation, but their legal status elsewhere is too uncertain for their use by businesses operating in other states. If the states of Pennsylvania and Michigan had lowered their corporate fees and taxes, and thus made the corporation form more generally available and attractive, they would have served all practical ends better than by the creation of a new form of nondescript business organization. 569. Syndicates and Joint Adventures A syndicate is denned as an association of individuals formed for the purpose of conducting and carrying out some par- ticular business transaction, ordinarily of a financial character, in which the members are mutually interested. It is, as respect- ing the persons composing it, a partnership, and the legal obliga- tions assumed by the members are, as between themselves, sub- stantially the same as those of an ordinary partnership. 12 A joint adventure is simply a partnership limited in scope and duration by the fact that it applies to but a single business transaction. The liability of the co-adventurers is equal, and as to third parties is entirely independent of the amount ad- " Great So. Hotel Co. v. Jones, 177 U. S. 449 (1899). Edwards v. Warren Linoline, etc., Works and Trustee, 168 Mass. 564 (1897). 11 37 Cyc., p. 661; Hambleton v. Rhind, 84 Md. 456 (1897); Hossack v. Ottawa Develop- ment Assn., 244 111. 274 (1910). Ch. 62] PARTNERSHIP ASSOCIATIONS 531 vanced. The members of such a partnership may, of course, make any agreement between themselves they choose as to their respective investments, interests, and liabilities, but this does not affect their liability to third parties. The members of a syndicate would undoubtedly be held liable to third parties as partners if the enterprise became abso- lutely insolvent. As most syndicates are formed for financial investments or underwritings, and either involve no obligations in excess of the amounts contributed, or, if otherwise, have well-defined and well-understood liability as to the syndicate transactions, and as the members of such syndicates are usually men or concerns of wealth and standing, the question of part- nership liability rarely arises. If there were any danger of such liability it could probably be avoided by organization under a declaration of trust with express exclusion of individual liability. CHAPTER LXIII EXPRESS TRUSTS AS A FORM OF BUSINESS ORGANIZATION 570. What a "Trust" Is In law a trust is created whenever property is placed in the possession of one or more persons in trust, to hold it and pay over the profits to designated beneficiaries. It originated in the desire of men to set aside property for the benefit of their wives or children, in such shape that the principal would be preserved intact and the income only would be used for the beneficiaries. Those who held the property thus set aside, were designated as trustees. A trust of this kind could be created by deed or by will. The rights of the beneficiaries, the duties of the trustees, and the rules for safeguarding the estate held in trust were gradually worked out by the courts of equity into a fair, well-balanced system. Trust estates were frequently created for the benefit of charitable and educational institutions. At times when money was loaned, the property by which it was secured was trans- ferred by a deed of trust to trustees, who in case of default sold the property and divided the receipts among the creditors. Where railroads and large corporations issue bonds secured in this way by deed of trust, the functions of the trustee or trus- tees become in some cases very extensive and of vital importance to the holders of bonds. In cases of bankruptcy, if the business needed care, trustees were appointed to conduct it, wind it up, and divide the surplus. In some of these cases it was sought to hold the trustees who were running a bankrupt business and the creditors for whose benefit it was being run, liable as partners. 532 Ch. 63] EXPRESS TRUSTS 533 This the English courts refused to do. 1 The courts in this country have followed the English courts in their decisions.2 571. What an "Express Trust" Is A trust is, as just stated, an arrangement by which a person known as the "trustee" holds property for the benefit and ad- vantage of another, known as the "beneficiary" or, in legal phrase, as the cestui que trust. An express trust is a trust created by an instrument in writing called a "declaration of trust," "trust agreement," or "deed of trust"; or it may be created by will. The parties to a trust are: (i) the creator, (2) the trustee, and (3) the beneficiary or cestui que trust. The property or subject matter may be real estate or money, goods, chattels,. or choses in action. Anything may be the sub- ject of a trust that can be held legally. Wherever the legal estate or interest is in one person and the equitable interest is in another, a trust exists. It is called a "trust" because it is founded on trust and confidence in the trustee, that he will carry out the wishes of the creator of the trust as expressed in the will or trust instrument. A trust is not a contract, but in a court of equity a tiust can be enforced, and hence all litigation concerning trusts is con- ducted in the courts of equity or chancery. 572. Legal and Equitable Title to the Property An essential feature of a trust is the vesting of the legal title to the 'property involved in the trustee. If it is real estate, every feature of ownership, title on public records, actual pos- session, liability for taxes, right to sue for trespass, etc., is in the trustee. No one else has power to sell, mortgage, or lease. Cox v. Hickman, 8 H. of L. Cases 268 (1860); Smith v. Anderson, L. R. 15. Ch. D. 247, 284 (1879). 'Hart v. Seymour, 147 111. 598 (1893); Mallory v. Russell, 71 Iowa 63 (1887); Mason y. Pomeroy, 151 Mass. 164 (1890); Mayo v. Moritz, 151 Mass. 481 (1890); Johnson v. Lewis, 6 Fed. 27 (1881); Taylor v. Davis, no U. S. 330 (1884); Lackett v. Rumbaugh, 45 Fed. 23-29 (1891); Wells-Stone Mercantile Co. v. Grover, 7 N. D. 460 (1898); 41 L. R. A. 252; Spotswood v. Morris, 12 Idaho 360 (1006); s. c., 6 L. R. A. (N. S.) 66s. 534 CORPORATE LAW [Bk. I- Every element of legal possession is in him. If there are several trustees, and one dies, the title passes to the survivors. As the legal title is in the trustee, so is the beneficial interest entirely in the one for whose benefit the trust was created. Being an equitable title, any dispute concerning its terms or interference with the rights of the beneficiary will have to be settled in a court of equity instead of in a court of law. 573- Who May Create a Trust It may be broadly said that everyone who is competent to make a will or to enter into a contract is competent to create a trust. Ownership of property and power to transfer it are all that is required to make a trust. If any solvent person has full title to property and has capacity to contract, he can transfer the legal title to a trustee to hold in trust. A person who is insolvent could not create a trust that would put his assets out of reach of his creditors. A person incompe- tent to contract by reason of minority, lunacy, or some other incapacity, could not as a rule create a trust that would bind him. The trust so created would be voidable Married women are practically under no disabilities in this country and may create trusts at their discretion. 574. Who May Be a Trustee The following statement from an English work sums up the qualifications necessary for a trustee: "A person to be appointed trustee should be (i) a person capable of taking and holding the legal estate, and (2) possessed of legal capacity and natural ability to execute the trust, and (3) domiciled within the juris- diction of the court." 3 The last item is a statement of the gen- eral requirement that trustees must be citizens of the state in which the trust estate is situated. The selection of a person to hold property in trust involves 1 Lewin on Trusts, p. 27. Ch. 63] EXPRESS TRUSTS 535 ' J " putting faith and confidence in his integrity: literally, the creator trusts him with the property. Because of this he is termed the "trustee" and the arrangement is called "a trust," meaning thereby the obligation resting on a person to whom property has been given for a particular purpose, to apply the property for that purpose. 575- Use of Express Trusts in Restraint of Trade When the large industries first undertook to combine and control their respective businesses, they organized under the form of an express trust. A controlling stock interest in each corporation was transferred to a board of trustees, who elected directors subservient to them, and in this way the trustees dominated the industries. The first great monopolies, the Stand- ard Oil Trust, the Sugar Trust, and the Bay State Gas Company, were each organized as an express trust, in which a board of trustees took over the stocks of the constituent companies and issued trust certificates to the owners. Thereafter, until the courts declared such organizations illegal, these boards of trus- tees were in control of their respective industries. The courts decided that trusts of this nature were illegal, not because of any objection to their form of organization, but because their objects were illegal. When the trust form was forbidden to these monopolies, holding corporations or large owning corporations were resorted to, but the name "trust" persisted and is still used to designate the great monopolistic corporations. This is as illogical as it would be to call large partnerships "corporations," and has accordingly resulted in much confusion of popular thought. By reason of this illegal use of the trust form, the word "trust" has incurred a certain enduring but entirely undeserved odium. It is necessary that its actual and legal meaning should be realized, if we are to understand how it may be used as a useful form of organization for the conduct of ordinary and entirely lawful businesses. 536 CORPORATE LAW [Bk. I- 576. Modern Use of Express Trusts in Business In Massachusetts prior to 1912, the corporation laws made no provision for the organization of real estate companies. To secure the advantages of the corporate organization so far as might be possible, those desiring to handle real estate created an express trust, by executing a written declaration of trust. The parcels of real estate or funds to purchase the property desired were placed in the possession of the trustees, who were given full powers to hold and deal with the trust estate so created. Those who executed the declaration of trust were named as beneficiaries, and their interests were represented by transferable trust certificates. Any profits were to be appor- tioned among the beneficiaries according to their interests. It was provided that neither the trustees nor the beneficiaries were to be liable for any debts or obligations of the estate. The trustees took the places of the directors in an ordinary corpora- tion, and the beneficiaries took the places of the stockholders. It seemed to work well in Massachusetts in handling real estate, and its use was gradually extended to other lines of busi- ness. Later it was taken up in other parts of the country and employed for various kinds of business enterprises. To what extent this has been done is not possible to ascertain, because, as it is a private arrangement between the parties, no public record is required save in a few of the states. Unless such an association gets into legal difficulties there is usually no data concerning it available to the public. 577. Associations Organized as Express Trusts The following list shows some of the better known concerns organized under the trust form: The Mackay Companies (Postal Telegraph) Great Northern Iron Ore Properties Texas Pacific Land Trust Amoskeag Manufacturing Company Ludlow Manufacturing Associates * Ch.6 3 l EXPRESS TRUSTS 537 Massachusetts Gas Companies Chicago City and Connecting Railways Collateral Trust Chicago Elevated Railways Collateral Trust North American Pulp and Paper Company Masonic Temple Trust (Chicago) Montgomery Ward Warehouse Associates Pepperell Manufacturing Company Massachusetts Lighting Companies New Hampshire Electric Railways Within the last few years this form of organization has been used extensively in Texas, Oklahoma, and the other oil regions of the South and Middle West for the purpose of exploiting oil properties. Most of these enterprises, being purely speculative, come to grief and those who have invested in them lose their money. This tends to bring the express trust into disrepute. It is obvious that these failures should not be attributed to the form of organization, as the investors would have fared no better had they bought shares in a corporation engaged in the same risky business. 578. Varied Nomenclature Applied to These Associations The fact that the express trust as a form of business organiza- tion is yet new is shown by the different names under which it is known. The latest and most complete work as yet pub- lished on the subject is entitled "Trust Estates as Business Companies." 4 The objection to this is that the word "estate" is so generally used to designate the property accumulated by an individual, that it gives a false impression of the express trust. In Massachusetts such associations have always been called "voluntary associations," which is an unsatisfactory descrip- tion in that it fails to differentiate them from joint-stock com- panies or incorporations. In some parts of the country they are termed "common law companies," to distinguish them from statutory corporations By Sears. 538 CORPORATE LAW [Bk. I- and joint-stock companies. This, though, is objectionable be- cause the common law has never recognized "trusts," which have been and are entirely the creatures of the courts of equity. The description of them as "associations under deeds of trust" is accurate but cumbrous. It is incorrect to call them partnerships, for they have no legal element of a partnership. 579. Misuse of Trust Form by Incompetent Parties Another thing that has tended to bring this form of business organization into disrepute is the fact that lawyers and others of little business or professional standing have advertised to organize such associations for small fees, and with little trouble to the promoters. Such organizations have been made with little concern as to the laws ol the state in which they were to operate, or to the needs of the enterprise for which they were to be used. Such careless and slovenly organization is apt to be disappointing and in some cases disastrous to the members. A recent and very competent writer on this subject says : The trust idea herein discussed has, in a few instances, been commercialized by so-called organizing companies in much the same way as the corporation laws of certain liberal charter granting states are advertised and exploited. Forms are furnished with apparently little regard to the particular purposes in view or the laws of the state wherein the trust is either established or will carry on its operations no warning whatsoever is given as to the methods to be followed and the strict rules of equity to which trustees are subjected are unnoticed. Those in search of a "form method," the avoidance of attorneys' fees, or "cheapness" in or- ganization, will generally be disappointed in the results which they secure. The author here ventures the prediction that this class of organizers will fare better under a corporate charter than they will as a trust. Incorporation at least has the check of state officials, and, proper steps once having been taken, corporate existence is presumed to continue; but a trust must always be a trust in fact as well as in name, and must be opera ted as such ; no mere ipse dixit of the trust instrument will create this result. No one but a competent legal advisor skilled in the laws of the state in question, and supplied Ch. 63] EXPRESS TRUSTS 539 with full knowledge of his client's affairs, can be relied upon to deter- mine that a trust should be created, to draft the trust instrument properly to effectuate the objects of its creation, and to advise and instruct the trustees in safe management of the trust estate. 6 580. Present Status of the Express Trust The arrangements by which property is placed in the pos- session of trustees is termed in law, as already stated, "a trust," and because in these organizations this trust is created by ex- plicit words, it is called an "express trust." The result is that a new and peculiar form of business organization, without in- corporation, formed by mere agreement of the parties, has come into use. In a report of the Massachusetts Commissioner of Corpora- tions made to the legislature of that state, he says: 6 The transferable nature of these shares gives to these associa- tions a continuity of duration usually limited by express provisions to the lives of the subscribers and 20 years thereafter. This pro- vision differentiates the form of association from an ordinary partnership, where the death of a partner dissolves the partnership and makes it, to a limited extent, similar to a corporation which may or may not have perpetual duration. The report also states in further characterization of the voluntary association, that a shareholder has no right to an accounting, as in a partnership, nor any right to examine the books as in a corporation; that a shareholder is not a tenant in common and has no interest in the property of the trust; that a shareholder is not responsible for the debts of the association ; and that a provision is frequently inserted to be made part of every contract that neither shareholders nor trustees are to be liable. In closing his report the Commissioner of Corporations sum- marizes the advantages afforded by these voluntary associations, as follows: Sears on Trust Estates as Bus. Cos. (1921), { 8. Report of Mass. Tax Com. upon Voluntary Assn., Jan. 17, 1912. 540 CORPORATE LAW [Bk. I 1. The experience of 25 years shows that they furnish a con- venient, safe, and unobjectionable form of co-operation, ownership, and management. 2. Their form of management is more flexible, more economical, and more convenient than that of a corporation. Trustees can do business with more ease and rapidity than a board of directors. 3. In particular they afford a convenient form for combining capital for the development and improvement of real estate, as the form of organization insures a continuity of management and control that specially appeals to investors in real estate, and which cannot be secured by a corporation on account of the change of officers each year. Trustees are not changed as frequently as are directors of a corporation. The Commissioner stated that where such associations sought capital in the open market they should be subjected to the same publicity requirements as corporations. 581. Common Advantages of Express Trusts and Corporations The use of the express trust as a form of business organiza- tion gives the following advantages which are also common to the corporate form: 1. Neither shareholders nor trustees are liable in excess of their personal interest in the trust property. 2. The shares are transferable as are corporate shares. 3. Trustees can do business and manage the trust property as directors do with the corporate business and prop- erty. 4. For all practical purposes an express trust can be made as permanent as a business corporation. In most states a trust can be created for one or more lives and 21 years more. 5. It is dissolved by agreement as readily as a corporation. 6. An express trust can sue and be sued as readily as a corporation can. 7. Shareholders have a right to accountings and to all such information as is proper. Ch. 63] EXPRESS TRUSTS 541 582. Advantages of the Express Trust Over the Corporate Form In the following particulars, it is claimed that the transaction of business under an express trust has advantages over the corporate form: 1. It can do business in ary part of the country as freely as an individual or a partnership. In some states, how- ever, the members may be held as partners. 2. It is not required to make out the reports, to take out licenses, and to pay taxes to the extent that is re- quired of a corporation. 3. Under some conditions the permanence of management secured by a continued board of trustees is better than the plan of annual elections. 4. The trustees may ask for court guidance in cases where the rights or powers of the trust are unadjudicated or not clear. 583. Statutory Regulations n?* The only legislation concerning express trusts is at this time found in Massachusetts and Oklahoma. The Massachusetts legislation is in substance as follows: 7 1. "Association" means a voluntary association under a written instrument or declaration of trust with the beneficial interest divided into shares. 2. The trustees of a voluntary association under a written instrument shall file this declaration of trust with the commissioner of corporations, and with the clerk of every city or town where the association has a place of business. Any amendment of the declaration of trust shall likewise be filed with the commissioner and the town clerks. 3. The commissioner of corporations shall each year send copies of all instruments so filed to the secretary of state, who shall print the same. 7 Cons. Laws of Mass.. Ch. 182; Voluntary Assn. 542 CORPORATE LAW [Bk. I- 4. Such associations may be sued and service of process on any one trustee is sufficient. The laws in Oklahoma are in substance as follows: 8 1. Express trusts may be created in real or personal prop- erty. The trustees have power to carry on or conduct any lawful business and to do anything in respect thereto that an individual might do. 2. Such an express trust must be created by written instru- ment subscribed by the grantors and duly acknowl- edged. It must then be recorded with the county clerk of the county where the property is situated or the business is conducted. 3. A successor must be provided for any trustee of an ex- press trust, to take his place in case of his death, resignation, removal, or incapacity. 4. Liability for all trust obligations extends to the whole of the trust property, but no liability affects the trus- tees or beneficiaries personally. 584. Liability to State Taxation Whatever property is held by the trustees of a business is taxable as other property held by individuals, firms, and cor- porations, neither more or less. An attempt in Massachusetts to tax the shares of voluntary associations was held unconsti- tutional. It is one of the advantages of such trusts that they are as yet not liable to the reports and taxes and licenses required of corporations. Such associations are subject to the federal income tax if the trustees are elected annually by the beneficiaries, but in Massachusetts under the income tax law enacted in 1916, the legislature has tried to equalize the taxation somewhat. Under this law, dividends or shares in associations and trusts having transferable shares are taxable, except in certain cases where Session Laws of Oklahoma. 1921, Ch. 16. Ch. 63] EXPRESS TRUSTS 543 the income of the association in trust would be exempt if re- ceived by an individual, or where the trustees or managers agiee to pay the tax. Where the dividends on transferable shares are not taxable, the income of associations or trusts is taxable if derived from annuities, professions, employments, trade, or busi- ness. Where there is a state income tax law, its terms and its construction by the state courts must be consulted, to ascertain whether the tax imposed is to be paid by the beneficiaries or by the trustees. 585. The Federal Income Tax When the federal income tax was first enacted it was held that such associations were not subject to its provisions. This has been changed, and the present ruling is as follows: Where beneficiaries holding certificates evidencing their interest under a so-called "Massachusetts trust" agreement annually elect persons delegated to conduct the affairs of the trusts, thus retain- ing a voice in the business, the trust is an association and is subject to the normal tax upon its income under the Acts of 1913, 1916, and 1918; the excess profits tax under the Acts of 1917 and 1918; the capital stock tax under the Acts of 1916 and 1918; and the cer- tificates issued by the trust to the beneficiaries are subject to the stamp tax under the acts of 1917 and 1918. Where the trustees originally appointed were to hold office during the entire period of the trust, the right of the shareholders being limited to filling vacancies, the beneficiaries not retaining any substantial control over the affairs of the trust, such a trust is not an association or taxable as such under section 230 of the act of 1918, but under section 219 relating to trusts. They are not subject to the excess profits tax nor the capital stock tax, nor are the certificates issued by the trustees subject to stamp tax. 9 The distinction is between an ordinary tiust, which is sub- ject to the rules governing trusts and trust estates, and an asso- ciation, wherein trustees are elected and where the beneficiaries * Montgomery on Income Tax Proc. (1922), p. 94. 544 CORPORATE LAW [Bk. I- thus retain a certain control of and voice in, the management of the business. Where such management is exercised by the beneficiaries, the organization is held to be a business associa- tion, and is subject both to income tax and capital stock tax. In his edition of 1922, Mr. Montgomery sets forth the situa- tion as follows: In practice, there are all kinds of Massachusetts trusts. In some the beneficiaries have little or no control over the manage- ment of the trust; others have practically all the characteristics of corporations (except the actual corporate existence and the limited liability of a stockholder in a corporation), and are governed by elaborate by-laws providing for annual meetings of certificate holders, and for the election of trustees for relatively short periods of time, thus vesting a large measure of control in certificate holders. From a tax standpoint the question is: Is a Massachusetts trust an ordinary trust or an association? If the latter, it is taxable as a corporation. If the former, the income, if distributa- ble, is taxable to the beneficiaries. 10 19 Montgomery on Inc. Tax Proc. (1922), p. 93. CHAPTER LXIV HOW AN EXPRESS TRUST IS ORGANIZED 586. Essential Provisions of a Trust for Business Purposes The essential provisions of any express trust organized for business purposes are as follows: 1. A deed or declaration of trust, drawn up to define the rights and powers of trustees and shareholders. 2. Two or more trustees who are authorized to take over and manage the capital, business, or other property supplied by the shareholders. 3. Shareholders who are beneficiaries and who receive transferable certificates representing their respective interests in the profits and in the property on dissolu- tion. 4. Provisions for division of profits, appointment of trustees to fill vacancies, and for dissolution at termination of the trust. 5. Provisions that no liability is to attach to either trustees or shareholders, but only to the trust estate. 1 587. The Declaration of Trust When an express trust is to be formed, if the object of the trust were only to hold real property and pay the rentals to the beneficiaries, it might be attained by simply turning over the property to the trustees by a simple deed of trust. If cash, or cash and property, as is usually the case, is to be transferred to the trustees for the establishment and conduct of some busi- 1 Husscy v. Arnold, 185 Mass. 202 (1904); Bank of Topeka v. Eaton, 100 Fed. Rep. 8 (1900). 545 546 CORPORATE LAW [Bk. I- ness enterprise, the purposes of the organization, the assets it is to operate with, the duties of the trustees, the rights of the bene- ficiaries, and many other details of the trust are set forth in appropriate legal phraseology in a formal instrument, termed a "declaration of trust," or sometimes a "trust agreement." In such case the declaration of trust must include all the de- tails that are usually set out in the charter and by-laws of a corporation. The shareholders of the trust as beneficiaries have no voice in the management, they can pass no by-laws, there is no annual election, they cannot remove or recall any of the trustees; hence the great importance of the declaration of trust, and the reason for its elaborate form. The deed of trust should plainly set out the following essential information : 1. The trustees and the immediate beneficiaries must be designated, and provision must be made so that others desiring to be beneficiaries can come in and assist in making up the required amount of capital. 2. If any property is to be transferred to the trustees, or if they are to purchase any particular business or prop erty, it must be designated and described. 3. The capital, if any, that is to be raised and paid over to the trustees must be specified, and its division into shares and the value thereof must be set forth. Both preferred and common shares may be prescribed. 4. The declaration must also state that the property ac- quired by the trustees is held in trust, and subject to the powers, limitations, and liabilities set forth in the instrument by which the trust is created. 588. Detailed Provisions of Declaration of Trust The declaration of trust or trust agreement, in addition to these more general matters, must specifically prescribe and set forth the following details : Ch. 64] EXPRESS TRUSTS HOW ORGANIZED 547 1. The duties of the trustees. 2. The powers of the trustees. 3. What consent on the part of the shareholders is required for the exercise of any special powers by the trustees. 4. Any special limitations or authorizations of the trustees. 5. The remuneration of the trustees for their services. 6. Any directions for the financial management of the trust. 7. How and under what circumstances payments of profits or of the trust funds are to be made to the holders of common and preferred shares. 8. Directions, if any, as to the sale or transfer of any of the trusteed property. 9. The continuance of the trust for such term as may be allowed by law. 10. Provisions as to registry of shareholders, the issuance of certificates, and the transfer of shares. 11. That the trustees shall have no authority to bind any shareholder by contract or to call for any assessment from them. 12. That all persons dealing with the trustees shall look only to the trust funds and not to either trustees or shareholders for payment, and that every order, con- tract, or obligation entered into shall stipulate that neither trustees nor shareholders are liable thereunder. 13. Provisions for annual meetings, reports and audits, and for filling vacancies among the trustees, with rules for voting. 14. How special meetings may be called and how notice of them is to be given. 15. The name of the trust and how the trustees shall be known. 1 6. Provisions for any other details of the trust business and organization not already prescribed. The declaration of trust must be signed by the parties inter- 548 CORPORATE LAW [Bk. I- ested, and in most cases will be acknowledged before a notary or other official. Care must be taken in preparing a trust that the power of alienation is not suspended, especially if any part of the trust estate consists of real property. 2 589. The Creators of the Trust Those who create the trust, who take the place of incorpo- rators in an ordinary company, must be competent to contract. No specific number is required. Many members or beneficiaries are not needed as original parties to the instrument of trust; in fact, a single person could create a trust. The trust being once created, anyone who came within the description of a beneficiary, or who subscribed according to the terms of the agreement, would have his money added to the trust fund, and would thereafter share in the rights and profits of the trust on the same basis as the other beneficiaries. 590. The Trustees The trustees are the permanent managers of the enterprise. They should be selected with care, for they are not, as directors are, elected annually. It is possible to remove a trustee for negligence or for malfeasance, but it is not usual, nor is it an easy thing to do. A trustee may also be a beneficiary in the trust and own shares as do other beneficiaries usually they do. None of the trustees need be signers of the declaration of trust. They may join in its execution, or they may formally accept the appointment by letter, but if they act as trustees under the declaration, that in itself would be a practical and sufficient acceptance of the trust. The original trust instrument should provide that as vacancies occur. in the board of trustees by death, resignation, removal, or incapacity, the beneficiaries shall fill them. Or, if desired, the trustees themselves might be em- powered to fill vacancies on the board. 'Howe v. Morse, 174 Mass. 491 (1899); Hart v. Seymour, 147 111. 598 (1893); Mallory v. Russell, 71 Iowa 63 (1887). Ch. 64] EXPRESS TRUSTS HOW ORGANIZED 549 Because of the continuance of the trustees in office, and of the stability of management that this gives, the express trust is an excellent substitute for the ordinary "close" corporation. It would be satisfactory also in many cases where an agreed manage- ment is desired, as often happens when a partnership is incor- porated or a minority interest demands protection. In such cases the trustees would hold the stock of the corporation and vote it as a block. 8 591. How the Board of Trustees Acts The board of trustees of a trust has abundant precedent for its operation in the usual procedure of a corporate board of directors, and in those directors of educational and charitable foundations that have existed for so many years as trusts. A business trust has no by-laws. All that ordinarily goes into a set of corporate by-laws is supposed to be set out in the declara- tion of trust, which can be made as compendious as may be required. In addition, such a board would have power to arrange its own details of procedure and methods of operation. That which usually is done by any corporate board of di- rectors is followed in most cases. A presiding officer, a recording officer, and a treasurer are chosen, and these officers are given authority to perform the duties of their particular offices. The trustees, or officers, if so provided, could appoint managers, superintendents, auditors, salesmen, and such other employees as might be necessary in the carrying on of the trust. In all of this they would be merely following the precedents laid down for them by an ordinary corporate board of directors. 592. Individual Liability under Trust Associations The most important question in relation to this form of business association is whether the individuals concerned, both the trustees and the beneficiaries, are likely to be held to in- dividual liability as in the partnership. It is a general condition See Ch. LVI, "Voting Trusts." 550 CORPORATE LAW [Bk. I- of the law that those who are associated in business with others are personally liable for all obligations incurred in the operations of the business. The corporation as sanctioned by the laws of most civilized countries is an exception to this rule. The vital question as to the trust associations is whether business can also be done by trustees under a declaration of trust with equal freedom from individual liability. Under the common law a trustee was held to be a principal, not an agent, and when he. contracted as trustee, he bound him- self personally. He had a right to be indemnified from the estate if he became liable without negligence on his part. If he wished to avoid all this, he could do so only by expressly stipulat- ing that only the estate and not himself was to be bound. The Supreme Court long ago laid down the general rule that, "If a trustee wants to protect himself from liability on a contract, he must stipulate that he is not to be personally responsible, but that the other party is to look solely to the estate." 4 In later Maryland cases the courts have explicitly stated the rule that the trustee must stipulate that he is not to be personally liable, or he will be so held. 5 In Massachusetts it has been held that where trustees signed a note "We as trustees, but not individually, promise to pay," they were not personally liable. 6 As a matter of precaution, most of the well-conducted trusts that are in active business are particular to have printed on all of their stationery and in particular on all bills, orders, invoices, and any other instrument that may involve or partake of a con- tract liability, a full disclaimer of all individual liability. The following disclaimer is of this nature : The Hampton Company is the designation of a Board of Trustees acting under a declaration of trust dated December 30, Taylor v. Davis, no U. S. 331 (1884). 1 Knapp v. Bagby, 126 Md. 461 (1915); Boyle v. Rider, 136 Md. 285 (1920). Shoe Leather Nat. Bank v. Dix, 120 Mass. 148 (1877); Adam v. Swig, 334 Mass. 584 (1920); Rand v. Farquhar, 226 Mass. 91 (1917). Ch. 64] EXPRESS TRUSTS HOW ORGANIZED 551 1909, and filed with the Northampton National Bank of Northamp- ton, Massachusetts. Any contract made or liability incurred by them binds only the trust property in their hands, and neither themselves nor the shareholders, beneficiaries of the trust, shall be held to any personal liability under or by reason thereof. Where this has been done, neither trustees nor shareholders have been held liable for anything beyond the money already invested in the trust. It is to be remembered, however, that trustees cannot avoid personal liability for torts or negligence. The declaration must not prescribe any control of the trustees by the shareholders. If the shareholders are in any way to manage the business, they will make themselves liable as part- ners. On this account the beneficiaries must not by means of annual elections appoint the trustees. This would be manage- ment by the beneficiaries and they would be held personally liable as in a joint-stock company. i xooa 'i H Part I The Corporation CHAPTER I PRINCIPLES OF FINANCE i. Problems of Financing The subject of this part of the present volume is the securing and handling of money and credit for incorporated business enterprises. If the terms money and credit were used with strict accuracy, the statement might be shortened by leav- ing out the reference to money; for, after all, credit in one form or another is almost the only element involved. But it is not necessary to enlarge upon limitations such as these which are purely technical. Corporate financing deals, first, with the methods of raising the initial capital needed for the enterprise, considering what securities to issue, how and to whom they should be sold, how best to utilize the funds thus secured, together with their proper apportionment for plant, equipment, and working capital; and second, with the accurate determination of any losses and profits and their allocation to dividends, surplus, sinking fund, and special reserves, and the enlargement of capital permanently invested. Financing is also concerned with the forecasting of business development and resulting financial needs and with provision for the business equivalent of a "rainy day," and in addition must take thought for the difficult problems that arise when a business enterprise becomes embarrassed or involved and is threatened with or overtaken by insolvency. 555 556 CORPORATE FINANCE [Bk. II- 2. Results of Unskilful Financing Financing is perhaps the least understood subject in the whole field of business. A great many men have proved themselves able and successful as producers, organizers, and sellers, but have failed utterly in handling their financial problems. A conspicu- ous example of this was George Westinghouse, the brilliant in- ventor, organizer, and salesman, who founded the Westinghouse Electric and Manufacturing Company, the Westinghouse Air Brake Company, and other enterprises. Westinghouse made a success of every business enterprise he touched except in so far as its financing was concerned. He was too eager to grasp the brilliant future he saw ahead of him to give the present the care and attention it required. More specifically, he did not possess the foresight to keep his enterprises properly provided with cash as they progressed. Consequently, the Westinghouse Electric and Manufacturing Company, of which he was the largest single stockholder and the active head, was twice faced with serious embarrassment, and in the end its too ambitious founder was compelled to relinquish its management. This case is not an uncommon one. In fact, it is generally true that men of an optimistic, emotional turn of mind who make good as promoters, producers, and salesmen, are just the ones who are prone to deceive themselves as to their own affairs and too often wreck a promising business on some financial reef that should have been easily avoided. It is surprising to find how often directors of important cor- porations give insufficient attention to the basic financial prob- lems of corporate business. Frequently, embarrassment or in- solvency which should have been clearly foreseen comes upon a board of directors when as in the case of the Westinghouse Electric and Manufacturing Company the members fancy themselves at the height of prosperity. Among smaller concerns the amount of ignorance regarding financial management is even greater. Every experienced busi- ness man has observed instances where enterprises that should Ch. ij PRINCIPLES OF FINANCE 557 have been profitable were half developed and then abandoned for lack of funds, when in nine cases out of ten the whole financial process might have been figured out in advance and the necessary funds raised with little difficulty. Instead, the enterprise too often drags out a painful existence for a few months or a few years, eats up the owner's capital, and at the end leaves him a poorer, but not always a wiser man. 3. Financing and Accounting Poor financing is apt to be combined with poor accounting; and in that case the unfortunate owner cannot enjoy even the empty satisfaction of a post-mortem diagnosis. This brings up a question on which there has been much con- fusion of thought the question as to the dividing line between the subject of financing and the subject of accounting. It is not purely an academic question, for in many business concerns the head of the accounting department and the head of the financial department are continually treading on each other's toes. There is undoubtedly a "No man's land" between the two subjects. When rates of depreciation, sinking fund requirements, valuation of good-will, budgets, quotas, and the like, are under discussion, there is constant danger of trespassing into account- ing territory; while, on the other hand, the accountants, espe- cially public accountants, have not hesitated to make many bold forays into financial fields. Frequently they are called upon to advise their clients as to the securing of bank loans, the proper types of bonds and shares to issue, the investment of capital funds, the declaration of dividends, and so on. We need not enter into the technicalities of the friendly con- troversy. A broad distinction, however, between the two fields of work and study may be easily made. Accounting, properly speaking, deals with recording and analyzing results that have been achieved; and the high and increasing esteem in which it is now held is due to the general recognition that the conclusions drawn by skilled accountants afford a safe, and indeed an essen- 558 CORPORATE FINANCE [Bk. II- tial basis, on which to predicate the financing and other impor- tant actions upon which the success of the business will largely depend. Financing, on the other hand, deals not with recording and analyzing, but with securing positive results; the best methods of raising money; what securities to issue; to whom they should be sold; and how the proceeds may be used to best ad- vantage for the promotion of the business. These are some of the typical problems which are clearly outside the scope of accounting. 4. Analogy between Business and Individual Financing A condition that has deterred many from the study of busi- ness finance is the popular supposition that many difficulties are to be encountered in solving its problems. One writer has even defined the science of business finance as "the modern black art," as if it were something mysterious and uncanny. Yet, whatever may be said of the difficulties pertaining to actual prac- tice, the essential principles of business finance are simple and readily understood by any one. There is, in fact, a close analogy between the financial problems of the business enterprise and the financial problems encountered by the ordinary indi- vidual in his daily life. The individual possesses both tangible and intangible assets. He has money, tools, land, and other tangible things. Also, he possesses health, skill, knowledge, and other assets that are in- tangible. Business divides its assets into things tangible and in- tangible in the same way; its plant, equipment, stock, and cash being tangible assets; while its good-will, trade-name, patents, and copyrights are intangible assets. The individual has his capital and his income, and from these he must make the necessary expenditures ; first, to maintain him- self in condition to do business; second, to increase his produc- tive and consequently his earning power. He must also reserve a portion of his income against the coming of old age or some Ch. i] PRINCIPLES OF FINANCE 559 prior time of need. He knows the laws of thrift and prudence, and knows that if he will obey them he will prosper. It will be shown that precisely the same kind of wisdom and foresight is required to invest properly the capital and income of a great business so that it shall continue to grow and prosper and shall not be short of funds and credit should an evil day un- fortunately come. The business, great or small, that does not keep its expenditures within its income is as certain to come to grief as the individual who spends more than he earns. An individual should, from time to time, take an inventory of his resources and liabilities, physical, intellectual, and spirit- ual, as well as material, and thus determine whether he is be- coming richer or poorer. In like manner every business should at regular intervals take an inventory, balance all accounts, sub- tract losses and add gains, and thus ascertain whether it is gain- ing ground or falling behind. 5. The Use of Credit All our greater businesses are conducted largely with bor- rowed money, and in this matter we may carry our analogy with the individual yet further. It is well to remember, however, that in such borrowing we are not engaged in that shiftless borrowing so severely and properly condemned by sages and moralists. Their strictures had no reference to borrowing or lending money for proper business purposes. For instance, when a young man makes a long-term loan and pays interest on it in order that he may take a college course or prepare for a profession, he is not acting foolishly but with the greatest wisdom; for the money so expended will bring him a wealth of skill and knowledge that will enable him to repay both loan and interest, and during his whole life the transaction will increase both his usefulness to society and his earning power. In the same way, when a business concern can borrow money to enlarge or improve its plant, to develop the enterprise, and gen- erally to increase its profits, such borrowing is not only permis- sible but commendable. 560 CORPORATE FINANCE [Bk. II- There are, however, some obvious limitations which will at once be recognized. No individual or business should borrow money unless it can be used to advantage and be properly cared for when it falls due. For this reason short-term borrowing is usually poor policy for either an individual or a business, unless it is to tide over a brief stringency or to "swing" some profitable transaction that can be completed quickly. 6. Fixed and Working Assets We can carry our analogy still further. All business invest- ments belong in one or the other of two classes: those that are fixed and permanent, and those that are temporary and designed to be converted into cash in a short time ; the first class is known as "fixed assets," and the second as "working assets." In every business there should be a proper proportion between the amount invested in fixed assets and the amount reserved for working capital. Both the individual and the business concern often fail to observe the necessary proportions. Not infrequently an agri- culturist buys more land than he can work profitably and we have a "land poor" farmer. Many country merchants buy more stock than they can sell immediately, and thus become "over- stocked." The less salable portion becomes shopworn and, as a consequence of this injudicious tying up of money, the merchant is without funds to replace the more salable articles. Many busi- nesses, both great and small, have met disaster because the neces- sary amount of working capital was not correctly estimated, too much being invested in plant and equipment or tied up in stock, while an insufficient amount was left to conduct the operations of the business. Sometimes a shortage of working capital is the result of changing conditions, as when at the close of the Great War many concerns found themselves, in the face of a falling de- mand, heavily overstocked with high-priced goods and materials. Usually, though, a shortage of working capital is the result of bad or mistaken judgment. Ch. i] PRINCIPLES OF FINANCE 561 It is always advisable for both the individual and the business to possess an emergency fund something in the nature of quickly convertible assets. From time to time, opportunities offer which can be taken advantage of only by the possessor of ready cash, and then the forehanded man or business, with cash or readily salable securities in hand, can act quickly and profitably. 7. The Budget Plan Both the individual and the business concern possess a certain income from which living or maintenance expenses must be drawn. If the income exceeds the amount required for support and the establishment of a prudent reserve or surplus, the balance is available for non-paying purposes; therefore, to both the indi- vidual and the business concern comes the question of how much of the income is required for operating and prudential purposes and how much, if any, may be properly utilized for the less essen- tial purposes, such as pleasure in the case of the individual, and dividends in the case of the business concern. To answer this question, the individual should, at the begin- ning of each year, estimate his income and his expenditures, as nearly as he can, so that the proper relations may be preserved between that which comes in and that which goes out. The business establishment should hi like manner determine whether an increase, a maintenance, or a curtailment of income may be expected, and in the light of this information arrange its budget deciding what amount of earnings shall be set aside for a reserve, what shall be applied to each department for up-keep, how much is needed for depreciation, what shall be expended for general operation, expansion, etc. Item by item this estimate should be scrutinized to learn where an outlay may be curtailed to ad- vantage, or where an outlay may be profitably increased, or where some new outlay may be made for the ultimate benefit of the business. Such a proceeding is a practical method of planning a financial policy; the plan as laid down can be, and should be, consistently followed. 562 CORPORATE FINANCE [Bk. II- 8. Fundamental Rules of Finance The following elementary rules of business finance apply alike to individuals and to the largest enterprises; the present work consists practically of the application of these general rules to various business problems. 1. Study and utilize all sources of capital, including earning power and credit. 2. Do not hesitate to borrow for legitimate business pur- poses when profits can be earned or losses avoided thereby, provided the loans can be repaid when due. 3. Do not dissipate capital on side lines and outside invest- ments. 4. Systematically accumulate assets, both tangible and in- tangible. 5. Always keep available sufficient cash and readily con- vertible assets to meet emergencies and to seize special opportunities. 6. Use income sparingly for living expenses and pleasure, but freely for business maintenance and development. 7. Use foresight which is the cardinal virtue in all financial operations; make budgets to govern all expenditures. These are the prudent, homely, indisputable rules for sensible financing. They have been preached and proven over and over again for many centuries past. The wisdom which they embody applies just as truly to the business of the United States Steel Corporation or to that conducted by Henry Ford, as to the affairs of John Smith. A man who can grasp these principles, hold them continually before his eyes, and apply them intelligently, is bound to handle his finances wisely both in his business and in his private life. However, simple as they are, to apply these fundamental principles to all the complex situations which arise in modern business is no easy task. Sound financing calls for clear thinking and a wide range of knowledge. CHAPTER II ORGANIZATION FOR BUSINESS 9. Forms of Business Organization l Wherever business is carried on, there are to be found three basic forms of business organization : 1. The sole proprietorship, i.e., an individual owning out- right his own business and usually managing it himself without much co-operation or assistance. 2. The partnership, in which a group of owners work to- gether under some form of partnership agreement. 3. The corporation, the impersonal owner, standing between the business and the individuals composing the cor- poration who have various kinds and degrees of claims upon the business. The first two of these basic forms sole proprietorship and partnership involve the personal relationship of a man or a group of men to the business; but the third form, which is a com- paratively modern invention, separates the owner or owners from the business and brings into being an impersonal, intangible thing a corporation in which the nominal or legal ownership is vested. The three basic forms of business organization are combined and recombined in many different ways under the laws and cus- toms of the various commercial countries, but analysis always reveals one or the other of the three forms predominating. This is shown by the short description, found later in the chapter, of three other forms of business organization not often used, but of interest here, as showing how difficult it is to get 1 See Book I, Ch. II, "Business Organization." 563 564 CORPORATE FINANCE [Bk. II- away from the basic types. These are the limited partnership, the joint-stock company, and the association under deed of trust. 10. Capital, Management, and Income It has been pointed out by writers on economics that, no matter what the business or the form of organization under which it is conducted, capital is required for its operation and this involves more or less risk; also that management must be pro- vided, and that, arising from the operation of the business, there should be income. Capital may be contributed directly or it may be secured by means of credit. In an individual proprietorship, one man supplies the capital, assumes all the risk, undertakes the management, and receives all the income. Under the partnership form, the partners as a body supply the capital, undertake the risk and the management, and receive the income; but among themselves there may be an infinite number of combinations. One partner, for instance, may supply all of the capital and assume the risk; another may supply the management; and they divide the income as may be agreed. Under the corporate form the risk is taken by the share- holders who supply capital under conditions that have been agreed upon. These shareholders divide the income, if there are different classes of stock, in rough proportion to their risk. The management, however, is not usually retained in the hands of the people who contribute the capital, but is turned over to directors and officers who may not personally be large shareholders. The tendency plainly has been to separate the supplying of capital for the business and the management of this capital so that these two need not be joined in one man or even in a small group of men, ii. Sole Proprietorship The first of the three basic forms of business organization the sole proprietorship is the simplest and is even yet the most Ch. 2] ORGANIZATION FOR BUSINESS 565 numerous. Small shops, farms, professional activities, and the like, are usually conducted as sole proprietorships. The. owner does not separate his ownership of the business from his manage- ment of it; frequently he does not even separate the ordinary management of his business affairs and the management of his personal affairs. He himself is the business and the business is a part of him. The simplicity of this form does not necessarily imply, how- ever, that it is applicable only to a small business. Many men of great wealth could properly regard the investment and man- agement of their funds as in itself a business, for this work some- times requires the services of a force of assistants, bookkeepers, and clerks. Then, again, an individual may embark upon a busi- ness enterprise which grows rapidly from year to year and becomes very extensive; yet the original proprietor may con- tinue to own and direct it all. This was the case, for instance, until a comparatively recent period, with the great department stores in Philadelphia and New York which were personally owned and managed by John Wanamaker. However, it usually happens, for reasons given below, that a business which is becoming large and prosperous finds the single proprietorship undesirable. 12. Disadvantages of the Sole Proprietorship On the other hand, advantageous as the sole proprietorship frequently is for the first years of business activity, it is not desirable for the permanent conduct of a business that is capable of much expansion. The more serious objections to the sole proprietorship for such a business are three in number. First, the capital of the business is limited to whatever the owner possesses, earns, or can borrow. Some kinds of businesses, if they grow at all, finance themselves, so that there is never need of any more capital than the amount with which the business was started; but the great majority of business concerns which are expanding require additional capital. 566 CORPORATE FINANCE [Bk. II- A second and even more serious, disadvantage is the strict limitation on the management of the business. The owner must depend upon employees for all executive work outside his own efforts, and it is difficult to retain men of real executive ability upon a salary. Ordinarily they prefer to go with con- cerns in which they themselves have or can secure an interest. If the individual owner wishes the services of such men, he must pay them exceptionally high salaries. To refer again to the case of John Wanamaker, it is stated that in the early history of the Philadelphia store there were at least a dozen employees who were drawing much larger incomes from the business than was Wanamaker himself. The third disadvantage is the ever present liability of the owner for all the debts of his business. He cannot legally dis- criminate between the property he has reserved for other pur- poses and that invested in his business. Everything he has is liable for the indebtedness of his business. 13. The Partnership Fundamentally there is no essential difference between the sole proprietorship and the partnership, except that in the partnership a group of owners take the place of the individual owner. There may be any number of partners and there are many different forms of partnership agreement. Partners are not necessarily equal, by any means, in respect to their invest- ments of capital and ability, or as to their division of the income. Sometimes one partner receives a larger proportion of the income than corresponds to his investment of capital in order to compen- sate him for a special contribution to the business, such as valu- able experience or connections, or unusual business ability. A partner coming in may not desire to be known as being in any way interested in the business, in which case he may by agreement become a "dormant" or "sleeping" partner. Again, he may desire to limit his own liability to the amount which he invests, in which case he may become a "limited" partner. " Ch. 2] ORGANIZATION FOR BUSINESS 567 14. Advantages of the Partnership There are some lines of business in which it is desired to avoid the legal regulation or the taxation to which the corporation is liable, and for this reason the partnership form is preferred. Mso, because of the personal element involved, the partnership is regarded as the proper form in which to organize such pro- fessional activities as those of lawyers, accountants, and engi- neers when two or more are to be associated in the business. In cases such as these it may be necessary to bring together in one organization considerable capital and the talents of many differ- ent men. The product of this form of organization, however, is not some material thing, but a direct personal service; hence the personal liability and the personal relationship, which are characteristic of the partnership form, are desirable and should be retained. For this same reason most concerns engaged in private bank- ing, in buying and selling securities, in underwriting, and the like, are not incorporated, but are organized as partnerships. Among the better known of these are the great international banking houses of J. P. Morgan and Company, Kuhn, Loeb and Com- pany, and Brown Brothers and Company. There are now but few, if any, of the large trading and manufacturing enterprises still in the partnership form. Arbuckle Brothers, the Baldwin Locomotive Works, and the Endicott- Johnson Company were among the last, having been conducted as partnerships until comparatively recent years. 15. Partnership Handicaps in Securing New Capital Of the three serious disadvantages of the individual pro- prietorship for general business purposes, only one is not found in the partnership. There is but little difficulty under the part- nership form in attracting high-priced business talent; in this one respect the partnership is probably superior to both the sole proprietorship and the corporation. The two other disadvan- tages of individual proprietorship the limitation on command of 568 CORPORATE FINANCE [Bk. II- capital and the personal liability- for all business obligations are, however, shared by the partnership. This is so as to the command of capital for several reasons. First, because of the personal character of the relationship between each of the owners and the business. This renders it highly undesirable that anyone should be included in a partner- ship unless he is personally acceptable to the other partners. Then, as all of the partners, except dormant or limited partners, have equal rights in the control of the business, and as any one of them may bind the entire firm by his acts or contracts, the consequences of bringing in an incompetent or unreliable partner may be disastrous. As compared with a corporation, all this introduces a serious handicap in searching for fresh capital with which to develop the business. It is necessary not merely to find a man with capital, but to find a man who has the integrity and the business ability to make him a safe associate, and beyond this a personality that will make him acceptable and insure har- monious relations with the existing partners. The quest is usually a difficult one. 16. Partnership Liability The other disadvantage, namely, the complete personal liability of each part owner, is even more serious in the partner- ship than in the sole proprietorship. The individual proprietor can suffer only through his own misfortunes or errors; the partner, however, may suddenly find himself face to face with heavy loss due to the bad fortune or errors of any of his partners. His own personal property except under one of the special forms of agreement above referred to is pledged to the creditors of the business until the last debt has been paid. If one of his partners proves dishonest or treacherous, he may be called upon to pay the bill not merely to the extent of his previous invest- ment in the business, but to the extent of all his personal holdings. It is this reason above all others that makes the formation of a partnership so weighty a matter, and one calling for such careful Ch. 2] ORGANIZATION FOR BUSINESS 569 consideration. Beyond this, however, on the death or the with- drawal of any of the partners, if an agreement cannot be reached with the retiring partner or with the estate, it may be necessary to wind up the business and possibly to go through all the trouble of a suit in equity for an accounting. In the face of all these disadvantages, it is not surprising that very few business concerns have retained the partnership form. Outside of the special classes of business mentioned, it is becom- ing every year relatively of less and less consequence. 17. The Corporation 2 Capital Stock The corporation is quite distinct from the sole proprietorship and the partnership. The capital is supplied by a group of per- sons called shareholders, or stockholders. The business is man- aged by officers and directors elected by the shareholders. In most states the shareholders have no liability for the debts of the corporation beyond the amount which they have contributed as capital. One of the distinctive features of the corporate form is the division of the capital into parts or shares, usually of compara- tively small amount. Because of this and because of the man- agement by officers and directors and the freedom from liability of the shareholders for the debts of the business, funds may be raised from the general public by putting these shares on the market; and it is much easier to finance a business of great mag- nitude in this way than through either individual ownership or the partnership. 18. The Corporation Management Under the corporate form the business is usually managed by only a part of the persons who supply the capital. Indeed, the active management may be in the hands of people who are not shareholders and who have supplied no capital. The corporation 2 For extended discussion of the corporate form, see Book I, "Corporate Law." 570 CORPORATE FINANCE [Bk. II- itself is regarded as having a distinct and separate entity from its stockholders. It is, from the legal standpoint, an individual- capable of doing business by itself. It may sue, may be sued by, and may contract with its own members, as well as with outsiders. The officers and directors conduct its operations in the corporate name. 19. Limited Partnerships A limited partnership may be formed only under special laws. It differs from an ordinary partnership in that one or more of its partners are inactive, sharing the profits but taking no part in the management of the business. The liability of these part- ners is limited to the amount actually invested by them in the business, and they are called "special" partners in contradistinc- tion to the others, who are called "general" partners. To secure the restricted liability of the limited partnership it is necessary to comply closely with the statutory requirements of the state in which the partnership is formed. In fact, the procedure necessary to form a limited partnership is almost as formal as the incorporation of a stock company, and failure to observe the required formalities may result in making the special partners liable as general partners. 20. Joint-Stock Companies s A joint-stock company is a partnership with its capital divided into transferable shares. Except in the state of New York, such a company may be formed simply by agreement. In New York special statutes provide for an organization known as a joint-stock company, which is similar to a corporation, and the formation of such associations is prohibited except as provided by the statutes. The courts in New York define these organi- zations as being partnerships with some of the powers of a cor- poration. In New York these joint-stock companies may sue 1 See Book I, Ch. LXII, "Joint-Stock Companies and Partnership Associations." Ch. 2] ORGANIZATION FOR BUSINESS 571 or be sued in the name of the president or the treasurer, and the individual members may not be sued until it is shown that the claim cannot be collected from the company. Several of the leading express companies were organized under the New York Joint-Stock Company Law; also some industrial and commercial businesses, as Robert H. Ingersoll and Brother. In all these cases the arrangement seemed to work very satisfactorily. In other states the joint-stock company is not considered a desirable form of business organization and is rarely used. 21. Associations under Deeds of Trust 4 . Various experiments have t>een tried at different times in the way of carrying on business through trustees. It was long ago decided in England that the actual owners of a business could not be held liable as partners if it was held in trust and was carried on by the trustees. The main object of utilizing the trust as a form of business organization was to secure this limited liability to enable a number of individuals to unite in a business enter- prise without the personal liability of the partnership. This could, of course, be secured in the corporation, but the trust was not subject to strict limitations of statutory law as was the corporation and it did not have to observe the many formalities required of corporations; also, owing to its freedom from statu- tory limitation, the trust could be used for purposes for which the corporation could not be used. This latter fact was indeed what brought the trust into its present position as a form of business organization. Up to 1912 the law in Massachusetts made no provision for corporations to deal in real estate. It was found that the trust could be used for the purpose and consequently a large number of real estate trusts under the name of "voluntary associations" came into existence. They were found convenient and effective and, as stated, not subject to the limitations and requirements imposed 4 See Book I, Ch. LXIII, "Express Trusts as a Form of Business Organization." 572 CORPORATE FINANCE [Bk. II- upon corporations. Accordingly they have increased greatly in number, and have been extended to many other lines of business. The use of the voluntary association under deed of trust has also spread widely in other states. At the present time many of the Texas and Oklahoma oil companies are operating under deeds of trust. The states are, however, one by one, imposing re- strictions on these voluntary associations, and it is probable that eventually they will be subject to the same requirements and limitations as are corporations. CHAPTER III THE CORPORATE ORGANIZATION 22. Origin of the Corporate Form The modern corporation did not suddenly spring into being as a device for overcoming the obstacles of previous forms of business enterprises. It has been slowly and painfully develop- ing for centuries, and in its present form is a composite of the ideas and the experience of many different races and generations of men. It is distinctly an evolution and the process is still far from completion. 1 On one side, the business corporation is closely related to the municipal and religious corporation. The jurists of the early middle ages conceived or rather adapted from Roman law the idea of the church as a legal entity, distinct from any of its officers or ministers. It was clear that the endowments, for in- stance, which were given to bishops and abbots were not intended for their personal enjoyment nor to be disposed of as they saw fit. It was desirable that the custody of these funds should be en- trusted to an owner that would, if anything of the kind could be devised, exist year after year and generation after generation, irrespective of human frailties or vicissitudes. Out of this need for permanence in holding religious property grew the idea of the permanent, continuing church, and of other religious and char- itable organizations existing as entities or "corporations," dis- tinct from the individuals who composed them. It was an easy step, when a similar need arose in business undertakings, to trans- fer this conception from religious organizations to business or- ganizations. 1 For detailed discussion of the corporate organization, see Book I, Part I, "The Corporate Form." 573 574 CORPORATE FINANCE [Bk. II- During the last three centuries the corporation has grown, both in Europe and in the United States, along parallel lines of development. The result attained is' not exactly the same, for there are many technical points of difference between the Ger- man Gesellschaft mil beschrankter Haftung, the French societe anonyme, the English "joint-stock company" and the American "corporation," but these points of difference are of no great im- portance compared with the central fact that in all these, and in all other commercial countries as well, there has come to exist a certain type of business association, the essential features of which are: 1. Little or no direct personal relation among proprietors or between the proprietors and the business; such rela- tions as do exist being on the impersonal basis of capi- tal invested. 2. Control and management by elected representatives, vir- tually acting as trustees for the proprietors. 3. Liability of proprietors limited to their investment or to some fixed amount proportioned to their investment. 23. Corporate Entity 2 Both the Continental courts and the English courts have tended always to regard the corporation or company as if it were a group of individuals, while in this country the tendency has been to follow strictly Chief Justice Marshall's famous definition in the Dartmouth College case, wherein he spoke of the corpora- tion as "an artificial being, invisible, intangible, and existing only in contemplation of the law." The logical simplicity of this view appeals strongly to the legal mind. In practice, however, we all know that the corporation has no existence and no interests apart from the existence and interests of its shareholders, creditors, and officers. The fiction is, though, a convenient one; in some cases too 8 See Book I, $ 20, Ch. 3] THE CORPORATE 'ORGANIZATION 575 much so, for by its means the corporation becomes an effective shield to protect the men back of it who are intent upon actions and policies for which they would not care to accept, as individ- uals, the full responsibility. Recognizing this abuse of the corporate form, the courts of this country have become more and more inclined in recent years to tear aside the corporate mask and look for the men and the motives behind corporate actions. Nevertheless, they are still tangled and blocked at every step by the thousands of precedents consisting of decisions based upon the fundamental idea of the corporation as a thing distinct from the men of whom it is com- posed, and progress is slow. 24. Stockholders The men who took part in the early English joint-stock enter- prises such as trading expeditions to the Indies or Americas were appropriately known as "adventurers." The title would not be inappropriate in many cases if it were applied to present- day stockholders, or shareholders, in corporations. The average shareholder in a large corporation pays for his holdings of stock, and in return has the right to his proportionate share of whatever profits are distributed. He has also the right which the small shareholder seldom exercises of voting for directors who are supposed to represent him. That duty having once been per- formed, he ceases to be a factor of any importance in the man- agement of the company until the next annual election; in fact, as a shareholder he probably does nothing except hopefully wait for and gratefully receive whatever dividends the board of direc- tors sees fit to allot to him. 3 25. Stockholders' Relation to Corporate Business In American practice the average shareholder, even of smaller corporation's, unless he happens to be also a director or officer, is not only helpless, but uninformed. He may be furnished, if it so ' See Book I, Ch. XVII, "Stockholders." 576 CORPORATE FINANCE [Bk. II- pleases the directors, with a fairly complete annual report; the more enlightened corporations even send out monthly or quar- terly statements of earnings. He does not, however, meet his directors and officers face to face unless as a purely personal or exceptional event. He does not ask questions; he has no repre- sentative to dig up information for him ; he is completely in the dark as to the plans formulated by the directors and even as to the real results and prospects of his corporation. There are of course some exceptional cases. A few stockholders occasionally drift into the annual meetings of large corporations, but these meetings are of so formal a character that the stockholders who attend are not likely to be men of much weight and influence. Partly because of these conditions, many able business men de- cline to invest in any corporation in which they cannot protect their interests by a controlling voice or at least a seat in the directorate. 26. Stockholders' Meeting 4 The larger corporations in the United States make it their custom to send out notices of annual meetings to all stockholders, and to forward with these notices a printed prqxy, which author- izes the secretary or some other officer of the corporation to repre- sent the shareholder at the annual meeting. Most of the cor- porations supply stamped envelopes and, if they do not hear from the shareholder, forward a second request for his proxy. All that the shareholder is asked to do is to sign his name, enclose the proxy in the envelope and mail it. Nevertheless the interest on the part of the average shareholder is so slight that only a small proportion of these proxies are ordinarily returned. It is easy enough to return the proxy, but it is just a trifle easier to drop it into the waste basket. Probably the average shareholder sees no reason why he should take action one way or the other. He does not know whether the corporation is being well-managed or whether the officers and directors deserve his support or not. See Book I. Ch. XLII, "Annual Meeting of Stockholders," and Ch. XLIII, "Special Meetings of Stockholders." Ch. 3] THE CORPORATE ORGANIZATION 577 Except in very unusual cases, when there is an opposition and when a campaign to get his support is carried on, he knows that his vote will not have the slightest influence either for or against any man or measure. Usually the secretary and one or two other officials of the corporation take the* proxies to the annual meeting, go through all the formalities of electing a chairman and- a secretary, pre- senting reports, casting votes, and carrying out whatever pro- gram has been agreed upon by the officers of the corporation. Every year, for instance, an officer of the Union Pacific Railroad Company takes a-satchel full of proxies, makes the trip from New York to Salt Lake City (the Union Pacific Railroad Company being incorporated in Utah) and holds the annual meeting. Even when action out of the ordinary is proposed, very few share- holders ever take the trouble to attend these meetings. 27. Helplessness of Minority Stockholders The minority stockholder is able to do little or nothing to pro- tect his interests even though he suspects impropriety on the part of his directors. 5 W. Bourke Cockran, an eminent attorney, representing a stockholder of the International Steam Pump Company, appeared before the Supreme Court of the State of New York in an effort to compel the directors of the company to furnish more complete data than his client had previously been able to secure. "Doesn't the existing law on corporations give you sufficient power to go in and inspect the books?" asked the Justice. "Why, your Honor," replied Mr. Cockran, "they would only laugh at anyone who really tried to get at the books. It would take until doomsday." Under recent decisions the New York courts have made it possible for shareholders to inspect the stock ledger and transfer books of their corporations for the purpose of procuring a list of the stockholders, but they cannot inspect the books of account. * See Book I, Ch. LVIII, "Protection of Minority." 578 CORPORATE FINANCE [Bk. II- 28. Status of Stockholders in Other Countries In other countries, the tendency of the management to ignore the stockholders has not yet gone so far. Corporations in these countries are not of such enormous size as those hi America. The custom of meeting the directors and officers at least once a year and of persistently seeking information as to the internal affairs of the company has not fallen so completely into disuse. Also the English statutes provide for the auditing of every company's accounts by an independent accountant elected by the shareholders. The auditor is responsible to the shareholders and not to the directors, and he is legally liable to the company for any loss occasioned by neglect or carelessness on his part. The courts have said that it is the duty of an auditor not to con- fine himself to verifying the arithmetical accuracy of the balance sheet, but to inquire into its substantial accuracy. The report of the auditor must be sent to the shareholders. The courts have further said that an auditor does not discharge his duty by sun- ply putting the shareholders in the way of obtaining information; he must go beyond this and state his conclusions in unmistakable terms. In addition to this effective auditing of the company's ac- counts, the annual meeting is a real and vital feature of the corporate system. The shareholders attend, hear reports, ask questions, and hear explanations. This "heckling," as it is called, is expected, and public opinion makes it an effective discipline of the corporate managers. To explain mismanagement to a crowd of angry and disappointed investors is not a pleasant thing to anticipate, and it makes the managers much more cautious in their administration of the corporate business. 29. The Board of Directors The board of directors has the final authority within a cor- poration. The board elects officers, determines policies, author- izes contracts, passes on methods of financing, declares or with- holds dividends, and in general manages all the affairs of the Ch. 3] THE CORPORATE ORGANIZATION 579 corporation. This describes their legal status and responsi- bilities. 6 In practice, however, boards of directors are likely to become mere appendages or echoes of some one or two individuals who actually direct the corporation. The real, final authority is fre- quently lodged in the president, if he is an active man and per- forms all the duties of his office, and the board of directors simply ratifies his decisions. This is frequently the case even though the directorates may be made up of able and forceful men. Under the American system they have no direct interest, except as shareholders, in the profits of the corporation, and cannot afford to devote a great deal of time and thought to its activities. They have confidence, presumably, in the president or in the chief officer or officers, whoever they may be, and they prefer for their own convenience and comfort to leave the whole corpora- tion in the care of its actual head. Under such conditions the thing that frequently happens is that the shareholders elect directors; the directors elect a presi- dent or other chief officer; and this man designates the other officers, fixes the policy of the concern, and carries on all its affairs subject only to the formal ratification of his board. So long as the president and other officials are well chosen, the sys- tem works well. Its weakness lies in the fact that the directors themselves are poorly informed and are left in a helpless or ignor- ant condition as compared with the officers ; hence they are quite unable to protect themselves or the corporation against practices on the part of the officers that are perhaps detrimental. In place of a representative democracy, which is the ideal form of govern- ment for a corporation, they substitute a small despotism. 30. Inefficiency among Directors This failure of the board to function is due, in the United States, partly at least to the custom of choosing directors of im- portant corporations from a very small circle of well-known busi- 8 See Book I, Ch. XVIII. "Directors." 580 CORPORATE FINANCE /Bk. II- ness men. The result is that one man may, nominally, serve on 10, 20, 50, or even 100 different boards. Even though some of these boards may be those of subsidiary corporations which transact nothing but the most formal business, nevertheless the men who are members of so many boards cannot be thoroughly informed as to the affairs of any of them. Within recent years there has been a significant tendency to reduce the number of directorates of which one man is a member, but the number is still too large. Henry L. Doherty, who is largely interested in public utility properties, is a director in 83 corporations; Alfred H. Smith, president of the New York Central Railroad, is a direc- tor in 88 corporations; Albert J. County, vice-president of the Pennsylvania Railroad, is a director in no corporations. The report of the Interstate Commerce Commission on the financial history and status of the New York, New Haven and Hartford Railroad, strongly condemns inactivity and ignorance on the part of the directors. To quote the plain language of the Commission : There are too many ornamental directors who have such childlike faith in the man at the head, that they are ready to endorse or approve anything he may do. . . . The minutes of the New Haven's meetings reveal that the Board confined itself almost wholly to ratifying and authorizing action; there was little real in- formation or discussion. None of the directors would have been so careless in the handling of his own money as the evidence demon- strated they were in dealing with the money of other people. 31. Real Function of the Board On the other hand, there is sometimes a mistaken idea that the board of directors ought to manage all the details of a busi- ness. Its real function is in selecting the right officials, outlining policies, and passing well-informed judgment from time to time as to the efficiency and honesty of the management. One of the most successful publishers in the United States, the late Henry Watterson, gave a very forceful opinion of directorates which run too much to details. Referring to the management of the Ch. 3] THE CORPORATE ORGANIZATION 581 New York World after the death of the organizer and former pro- prietor, Joseph Pulitzer, Colonel Watterson said: I understand that the paper is edited by a board of directors. You might as well try to run a locomotive by a board of directors. The moment the wisdom of one man or two men is superseded by the folly of one man or two men, the efforts of a lifetime may then and there be wrecked. It has been done repeatedly. In other words, the quick and usually correct decisions of one or two men familiar with the conditions are preferable to the com- promise decisions of a body of men, even though these 1? tter may be, as to individuals, quite as capable. 32. Compensation of Directors It has been suggested that the reason for the inefficiency and tiie light ethical standards characteristic of so many directorates, is to be found not only in wrong practice in selecting these men, but also in wrong practice in compensating them. In many for- eign countries, notably in Continental Europe, it is the custom to distribute among the directors at the end of each year a fixed percentage of the net profits; thus each director, even though he may not be a heavy shareholder, has a direct and personal inter- est in building up the profits. He is less likely to wink at incom- petence or to avoid criticism that would be for the good of the corporation, if he realizes that he must himself pay a portion of the penalty in the form of reduced compensation. Paul War- burg, formerly of the firm of Kuhn, Loeb and Company, has ex- pressed his belief that in this country we should follow the Euro- pean plan of paying directors in proportion to the profits the corporation earns under the management. One important gain in this plan is that it becomes easier to secure as directors men who may themselves have only a small shareholding interest in the corporation; the range of choice is widened. As matters stand now, a man who becomes a director of an important corporation usually takes the position for one of three reasons: because he has a large share-interest that he feels he 582 CORPORATE FINANCE [Bk. II- should protect, because it adds to his prestige, or because it gives him a connection or "inside" information that has a cashable value. The second motive has a strong influence in making up the directorates of banking institutions. "Membership on the boards of good banks," someone has said, "is largely a social function." This is not the way to get efficient, hard-working directors. Under the American system it is a common practice to pay nominal fees for attendance at board meetings, but these seldom amount to more than $20 a meeting, and are not a factor of any real weight. CHAPTER IV THE CORPORATION IN MODERN BUSINESS; HOLDING COMPANIES 33- Widespread Use of the Corporation The great commercial agencies of the United States list some 2,180,000 individuals, firms, and corporations as being in busi- ness. Over 320,000 corporations in the United States filed income tax returns for the calendar year ended December 31, 1919. This would seem to indicate that about 15% of all busi- ness enterprises are organized in the corporate form. However these figures do not in themselves give any adequate idea of the relative importance of the corporate form. The 85% of business enterprises owned by individuals or by partnerships include, with comparatively few exceptions, only small concerns. The 320,000 corporations include almost every important business undertaking of the country. It is interesting to note the distribution of the corporations of the country on the basis of their capitalization as shown by the last census: 9 184,554 corporations with capital of less than $1,000,000 3,569 " " $ 1,000,000 to $ 2,000,000 1,290 " " 2.000,000 " 3,000,000 639 " " 3,000,000 " 4,000,000 411 4,000,000 " 5,000,000 785 " " 5,000,000 " 10,000,000 660 " " 10,000,000 " 50,000,000 75 50,000,000 " 100,000,000 54 " " " 100,000,000 and over In other countries, also, large enterprises are almost always organized under the form which there corresponds to our corporation. 583 584 CORPORATE FINANCE [Bk. II- 34. The Small Corporation Yet, as shown by the foregoing table, the corporation is by no means confined in its usefulness to concerns doing an enor- mous business. On the contrary, it is becoming every year more and more frequent to organize even small enterprises in this form. The "one-man" or "close" corporation is no longer an isolated phenomenon. Thousands of men who prefer to have themselves and their estates relieved from possible liabilities due to misfortunes of business, or who wish to organize in such a way that it will be easy to sell interests or gradually to transfer the control, have decided to adopt the corporate form. Also it is becoming more and more common to incorporate the estates of deceased persons and to distribute shares in the corporation among the heirs of the estate so that a proper division of interest may be secured without a physical division or forced sale of the property. Small corporations for temporary purposes, also, are not uncommon. An individual may get up a corporation to publish a book or to carry through a speculation in real estate. Indeed, the question is often raised whether this tendency is not carried too far; whether enterprises that would be better off as temporary syndicates or as special partnerships, are not unthinkingly organized as corporations. As regards many in- dividual cases, the suspicion is no doubt well justified. On the whole, however, there can be little question but that the corpora- tion has proved itself useful, sound, and economical, not only for nation-wide and world-wide concerns, but for small and local enterprises as well. 35. The Army of Stockholders Another point to consider here is the great number of persons interested in corporations as holders of their stocks and bonds. A single corporation United States Steel has over 189,000 stockholders. This is of course exceptional, but when we con- sider that over 320,000 corporations make annual income tax Ch. 4] THE CORPORATION IN MODERN BUSINESS 585 reports it is obvious that the total number of stockholders is far up in the millions. On a smaller scale, the same thing is true in other countries. It constitutes one sound reason for saying that the corporate form of organizing enterprises is becoming one of the far-reaching factors in modern business life. 36. Is the Corporate Organization Efficient? Adam Smith, the first and perhaps the greatest of economists, was extremely skeptical as to the usefulness of the large "joint- stock" companies which in his day were just beginning to play a prominent part in business life. "Without a monopoly," he says, "a 'joint-stock' company, it would appear from experience, cannot long carry on any branch of foreign trade, for it is a species of warfare in which the operations are continually changing, and which can scarcely ever be conducted successfully without such an unremitting exertion of vigilance and attention as cannot long be expected from the directors of a joint-stock company." Elsewhere he asserts that "negligence and pro- fusion must always prevail more or less in the affairs of a 'joint- stock' company." In view of the rapid spread of the joint-stock or corporate form of organization and the immense number now in existence, it may seem at first glance that wise old Adam Smith for once was entirely wrong. Yet, if he were to step into twentieth cen- tury life and read all the details of the various corporate failures, some of them verging on the scandalous, that are from time to time brought to light, he would perhaps not be easily convinced. 37. Reason for Adoption of Corporate Form As a matter of fact, it is probably true that the many advan- tages offered by the corporate form, such as the freedom it offers from individual liability, its convenient stock system, its per- petuity, etc., are more responsible for its widespread adoption, than any claim it can reasonably offer to superior efficiency. There are some features of corporate organization which are 586 CORPORATE FINANCE [Bk. li- no doubt an Improvement in respect to efficiency, over any other forms of organization. The people who supply the money are not necessarily the ones who personally manage the enterprise; and this leaves, or should leave, an opportunity to engage men of special talent as managers. The custom at one time was to select one of the largest stockholders as the nominal president of an important bank, railroad, or manufacturing corporation, but this has now been largely abandoned in favor of making the responsible manager of the institution also its president, although he may hold but a few shares of stock. On the other hand, the most important or influential stockholder, instead of becoming president, is now more frequently made chairman of the board a position which usually pays no salary. Furthermore, it is at least theoretically true that the creation of a board of directors who can oversee and direct ks officers, is a striking gain. 38. Causes of Corporate Inefficiency While the corporate form of organization has many ad- vantageous features some of which should contribute directly to its efficiency, as suggested in the preceding chapter, these ad- vantages are too often nullified by the selection of incompetent or overoccupied directors. As Adam Smith foresaw, these men are not so zealous in protecting the shareholders as they are in advancing themselves. Sometimes responsibility is so divided that it rests too lightly on the shoulders of each individual director. Hartley Withers makes the interesting comment that "the real business of most boards is done by a small minority who save the rest from the consequences of their inexperience." He continues: In actual practice the notion that the board is chosen by the shareholders or is really representative of the shareholders, is generally a delusion. The board either forms itself or is formed by the promoter and fills its own vacancies, subject only to the purely formal confirmation of the shareholders. The officers are chosen by the board or by one another, and joint-stock companies are thus governed in practical fact by a self-elected oligarchy. Ch. 4] THE CORPORATION IN MODERN BUSINESS 587 This is true not only in London, which Mr. Withers has in mind, but in New York, Montreal, Paris, Berlin, and every other part of the world. How do these self-chosen oligarchies work, and what do they accomplish? 39. Insolvency of the Northern Pacific During a period of almost ten years, Henry Villard was not only a director of the Northern Pacific Railroad Company, but was president of the company, and was generally regarded as its active and responsible head. In his "Memoirs," no doubt wishing to relieve himself in part at least from responsibility for the insolvency of the company under his management, he says: In 1891 Mr. Villard . . . made . . . his last official tour of inspection of the main line and principal branches of the Northern Pacific . . . The most alarming impression of all made upon him was the revelation of the weight of the load that had been put upon the company by the purchase and construction of the longer branch lines in Montana and Washington, which he then discovered for the first time .... They represented a total investment in cash and bonds of not far from $30,000,000, which together hardly earned operating expenses. The acquisition and building of these disappointing lines had in a few years absorbed the large amount of consolidated bonds set aside for construction purposes, which had been assumed to be sufficient for all needs in that direction for a long time. It is clear that Mr. Villard, whatever may have been his abilities and good intentions, had not been devoting sufficient attention to the business of this corporation to intelligently direct its affairs. 40. Management of the Colorado Fuel and Iron Company Some interesting testimony along somewhat the same line was given by John D. Rockefeller, Jr., when called before a subcom- mittee of Congress and questioned as to his control over the Colorado Fuel and Iron Company. Mr. Rockefeller testified that his father held 40% of the common and 40% of the preferred shares in this company. He stated that he personally was a 588 CORPORATE FINANCE [Bk. II- member of the board of directors, but did not attend meetings, and explained that he had every confidence in the officers of the company and kept in touch with them by correspondence. The chairman of the committee intimated that Mr. Rockefeller should have attended an important meeting in October. "If you mean that I should have gone to Denver to attend a meeting of the board of directors," was the reply, "I will say that it is not by attending the board meetings that we keep in touch with the officers. If the time comes when we cannot rely on the officers then we will get somebody else, for it is impossible for us to attend to all of these things ourselves, and we have got to get the ablest men obtainable to act for us." 41. Present Status of the Corporation In spite of the defects that develop in the corporate mechan- ism and the abuses that sometimes creep in when businesses are conducted under the corporate form, it does not follow by any means that the corporate form is to be condemned. The perfect system of business organization has not yet been devised, and abuses will creep in under any existing form of business organi- zation. Furthermore, the defects of the other existing forms of business organization are greater than those of the corporation and, on the other hand, the corporation possesses advantages which are found in none of these others. It is, in short, the most useful form of business organization that has yet been devised. To sum the matter up, it may be said that without the use of the corporation or some effective substitute the vast extension of modern business could not have been effected. Although merely an immaterial form, it has nevertheless wielded an economic and social influence greater than any other purely conceptual entity of the last century. The contribution of the corporation to the evolution of the form of modern in- dustry has been no less potent than that of machinery to its technique. 1 Dewing on Finan. Pol. of Corp. Ch. 4] THE CORPORATION IN MODERN BUSINESS 589 42. Holding Companies A striking development of recent years has been the growing use and importance of companies which hold the stock of other corporations. There was originally no thought that corpora- tions might be organized for any other purpose than to conduct directly the business operations specified in their articles of in- corporation. It was in time discovered, however, that among the possible activities of a corporation might be the holding of the securities of other corporations. At the beginning, the only use made of this power was to purchase interests that could be regarded as useful to the corpora- tion or as subserving the main purpose for which it was created. This remains today the most common and important purpose for which corporations acquire the shares of other corporations. But the holding company device has proved extremely useful also for another purpose on which public attention has been largely centered. This purpose is to achieve a combination of competing concerns which will restrain competition and be within the requirements of the law. This subject has been so fully discussed in various books and articles that it needs but brief reference.2 43. Development of the Holding Company Before the adoption of the "holding" company device, com- binations of competing concerns had been effected in several different ways. The first attempt to achieve such combinations in the United States was made by competing railroads which worked out various "gentlemen's agreements" for the regulation of rates and competitive methods. These agreements never stood the strain of every-day use for any long period. They always broke down because they were not hard and fast con- tracts; they were differently interpreted by the various indi- viduals who entered into them and they had no legal sanction. 1 See Book I. Ch. LVII, "Holding Companies." 5QO CORPORATE FINANCE [Bk. II- Another form of combination that has proved unsuccessful in this country though it has worked to some extent abroad is the "pool" or selling agency, which is an agreement to restrict production and sales, and which frequently accomplishes this purpose by having all the sales of the competing companies handled by one selling organization. This arrangement was found to be illegal in this country and was given up more than a generation ago. 44. The Export Association In 1918 the pool or selling agency was legalized for export purposes by the passage of the so-called "Webb-Pomerene Law," which expressly authorizes the formation of export associations of "any corporation or combination, by contract or otherwise, in the form of two or more persons, partnerships, or corpora- tions." Perhaps the best-known organization under this law is the Copper Export Association, Inc., in the formation of which seventeen companies participated, all of them prominent in copper production, refining, or export. In the early part of 1921 this association held some 400,000,000 pounds of refined copper for resale in foreign markets. Against this, to finance its con- stituent companies, it issued $40,000,000 of gold notes to be paid from the proceeds of its stock of copper as this was sold. 45. The Trust and Its Successors The successor of the pool or selling agency for domestic activity was the monopolistic "trust." Under this form of com- bination, controlling shares in competing corporations were turned over to a group of trustees who issued in exchange trustees' certificates. The trustees were able in this way to direct all the corporations and to restrain their competition with each other. In the late eighties this arrangement also was found to be illegal and the trusts already formed were dissolved. Shortly afterward began the use of the "holding" company to accomplish this same purpose. One corporation was formed Ch. 4] THE CORPORATION IN MODERN BUSINESS 591 which purchased the controlling shares of competing corporations and was thus able to direct them in the same way that the trusts had previously done. A variation of this was the formation of a large corporation that bought up the entire plants, patents, and properties of com- peting companies. Payment was usually made in securities of the large corporation, which the absorbed corporations distri- buted among their stockholders before they were dissolved. The same large corporation would also, where it seemed advan- tageous, merely buy up stock enough to control and would in that case act as the usual holding corporation. Both of these plans are in use today, and both may be dis- solved by the courts, if evidence is brought forward showing that the arrangement is being used to stifle competition, to enhance prices, or to restrain trade. 46. Present Status of Holding Companies Out of the discussion and the various legal measures that have been taken to restrain them, there has arisen a popular feeling that all holding companies are questionable, and it has even been seriously proposed that corporations should be for- bidden to hold stock in any other corporation. Yet as a matter of fact, no real legal objection to a holding company in itself has ever been raised. The only question that has arisen is whether the particular holding company or companies have been used for purposes of restraining trade and competition, and it is that use which is forbidden. For any purpose that is legal for a corporation, a holding company may be used as effectively and with as little legal objection as ever. There are two purposes for which the holding corporation may be legitimately used : i. To bring about a grouping or combination of concerns that are non-competitive. This occurs most fre- quently in the public utility field. 592 CORPORATE FINANCE [Bk. II- 2. To control subsidiary corporations in such a way as to advance the main interests of the holding company, but not with intent to prevent or restrain competition. The holding corporation in such case is designated as "the parent company." to wjiJhim- fti ui'bf Hf-mr/ 47. Holding Companies in the Public Utility Field The best illustration of the use of the holding corporation for the first purpose is to be found in the public utility field. There, as stated in a brief filed with the Interstate Commerce Commit- tee of the United States Senate :s The total capital employed in electric, gas, street and interurban railway companies, commonly called "public utility corporations," in this country today is estimated to exceed eight billion dollars. Of this capital, nearly five and a half billion dollars are controlled by holding companies and their subsidiary companies. Of the approximately eighty-nine millions of people served by electric light and power and gas companies over sixty-two millions (approx- imately 70 per cent) are served by holding company systems. 48. Advantages of the Holding Company The chief advantages of the holding company as used in con- nection with public utilities are: 1. The able management and expert assistance supplied by the holding company. Most of the local companies are in small cities and do not have the resources which would enable them to employ high-priced talent. The holding companies, through their superior resources and organization, are able to supply this and thus to increase the efficiency of the local companies. 2. The more adequate financing made possible by the standing and superior marketing facilities of the holding com- pany. The securities of the local public utilities can be sold 'Quoted in 4 Dewing on Finan. Pol. of Corp., p. 130 (footnote). Ch. 4] THE CORPORATION IN MODERN BUSINESS 593 only in or near the place of their operations; the securities of great holding companies, though largely based upon these same local securities, enjoy a national and even international market and consequently can be sold more widely and on a much better basis. Yd smoDTjvo vli-" ->/IT .*>Iiw; tot oiuJimirt yfno 49. Parent and Subsidiary Corporations A subsidiary corporation may come into existence through the creation of a separate corporation to handle a distinct phase of a company's business, or through the purchase of interests in companies previously existing, the main corporation being in this case the holding company. 4 The use of subsidiary corpora- tions is becoming more and more extensive. A certain manu- facturing corporation, for instance, has no less than six sub- sidiary corporations, i.e., one operating company, one selling company, one purchasing company, one company owning a short railroad, one real estate company to buy lands and to erect buildings, and another company to operate these buildings. The advantage of forming a distinct corporation in such a case, rather than to simply establish another department of the business, is not always clear to the outsider. Various reasons may lead to its formation. Frequently a subsidiary corporation is organized to meet personal requirements. A first-class real estate man, for example, may not desire to come to a corporation as a paid employee, but would be willing to assume the manage- ment of a distinct corporation, even though this be subsidiary to the other corporation, under conditions that would enable him to secure adequate profit. Another condition frequently arising is where it is desired to give the manager of a plant, or of a branch office, an opportunity to acquire a personal stock interest in the operations directly under his control, and this can be most easily done through the formation of a separate corporation. Other motives may come See Book I. f 527. 594 CORPORATE FINANCE [Bk. II- into play, as for instance in the case of a furniture business which included among its activities the sale of papers for wrapping and packing furniture. This company found that difficulty was being experienced by its sales force in selling people interested in suh pcapers, because of the impression that the salesman had only furniture for sale. The difficulty was easily overcome by forming a separate company to handle the sale of paper, with a separate name, stationery, and sales manager, but otherwise conducted as a part of the parent business. It may be thought strange that a corporation holding a charter and grant of powers from the state, could be organized so lightly and for so minor a purpose, yet such incorporations are not at all uncommon. It has become so easy and so customary to organize a corporation for some specific purpose, that it is frequently done with little thought and often when little or nothing is gained. The arrangement is in many instances of the greatest advantage, and we should not be misled by any popular outcry against corporations and holding companies into con- demning or endeavoring to prevent practices that on the whole make for business efficiency. *fI>:;!'> I'-'H: / Part II Corporate Securities CHAPTER V COMMON STOCK i 50. Owned and Borrowed Capital The capital funds used in any business enterprise fall into two classes: "owned funds" and "borrowed funds." In an in- dividual proprietorship or in a partnership the distinction is clear and easily made. The capital funds of such a business are represented on the liability side of the balance sheet, first by obligations, or "borrowed funds," and secondly by proprietor- ship, including whatever surplus has accumulated. In a corporation the distinction between "owned" and "bor- rowed" capital is not always so clear. As in the partnership or sole proprietorship, the capital funds are represented on the liability side of the balance sheet by : 1. Its obligations or "borrowed funds." 2. Its capital stock, surplus, and reserves which take the place of the proprietorship accounts of the other forms of business organization, and represent the "owned funds" of the corporation. But any outstanding bonds are entered among the borrowed funds as a matter of course, and equally as a matter of course any outstanding preferred stock, as part of its capital stock, is entered among its owned funds. Yet the distinction between bonds and preferred stock is not always clear. Many modern ;(>j;y7 See Book I. Ch. X. "Stock." 595 596 CORPORATE FINANCE [Bk. II- issues of preferred stock are not only redeemable, but carry as one of the conditions of issue a sinking fund provision to insure this redemption. On the other hand, participating bonds which share in the profits of the corporate business beyond their fixed interest are occasionally issued, and income bonds the interest on which is payable only when earned, are a not uncommon feature of corporate financing. Indeed, it would be difficult to fix on any dividing line which clearly separates the shareholders of a corporation from the holders of its bonds. Nevertheless, we may in general follow the customary line of distinction and say that the bonds, notes,' accounts payable, and other obligations of a corporation may be regarded as repre- sentative of borrowed capital, and that its outstanding shares of capital stock, both common and preferred, may be regarded as representative of owned capital. Some companies have practically nothing but owned capital; that is to say, their borrowings are almost nil. Ordinarily the only corporations in this condition are those which have just started, or those which are small and struggling and have not the credit which would enable them to borrow even on short time. Once in a while, however, we find a large corporation which follows the same policy. For instance, the W. L. Douglas Shoe Company, with a capitalization of common and preferred stock of over $5,000,000, carries on the liability side of its balance sheet only common stock, preferred stock, and current accounts pay- able. The same thing is true of the Singer Manufacturing Com- pany, which has $90,000,000 of common stock but no funded debt of any kind. \y>'ff> i ?<><[ off; 51. Stocks and Shares The title of this section is that of a very readable English publication to which reference is made below. At first glance the combination of words in the title seems to the American reader so much nonsense, for in the United States we are accus- tomed to apply the two words "stocks" and "shares" almost Ch. 5] COMMON STOCK 597 indiscriminately, both meaning the units of a corporation's owned capital. We derive our meaning of the word "stock" in its financial sense from its original meaning of something heaped up like a stack ; this is the sense in which it is used in the phrase "stock-in-trade." Adam Smith uses the word to mean the capital of a firm or company, and this meaning has survived in the United States, but not in Europe. In England, stock is distinguished from shares by the fact that it is divisible into, and transferable in, odd and varying amounts, ranging from tens of thousands down to a penny. At the original subscription any- one may take any odd amount of the stock that he cares for. The Stock Exchange calls the amount that is not divisible by one hundred, a "broken lot." Stock is quoted on the London Stock Exchange at so much per 100. Shares are distinguished from stock by the fact that they are expressed in terms of definite amounts and are indivisible. There are, however, some few English companies that will transfer tractions of shares. 2 52. United States vs. English Practice In the United States there is no security which corresponds to what the English call "stock." The owned capital of any corporation is always represented by an issue of shares, each share being of a uniform amount with the other shares in the same series, and of like standing and rights. In both countries the capital stock of the corporation may be of two or more classes, which in this country are usually called "common" and "pre- ferred." In England the more usual titles are "ordinary" and "preference," and in that country there is a much larger variety of shares than we have here. There are "deferred shares," "founders' shares," "deferred ordinary shares," "preferred ordi- nary shares," and so on almost indefinitely. In this country, after we have used the terms "common" and "preferred" we usually fall back on such matter-of-fact titles as "Class A," "Class B," "first preferred," "second preferred," and the like. 1 Hartley Withers on Stocks and Shares, pp. 33-38. 598 CORPORATE FINANCE [Bk. II- 53. "Common Stock" or "Ordinary Shares" 3 In the United States we speak of "common stock"; in England they use the term "ordinary shares." The two ex- pressions are practically identical in meaning; both refer to shares which have no special privileges or rights but which are entitled to whatever capital or income remains after prior claims have been satisfied. One verbal exception to this general state- ment may be noted. In English usage there are sometimes "deferred" or "deferred ordinary" shares, which are inferior in claims to the so-called ordinary shares. In this case the shares that are called ordinary are really "preferred." Occasionally this same practice is found in the United States. For instance, the Nassau Gummed and Coated Paper Company has two classes of common stock, which are known respectively as ' Common Class A' " and "Common Class 'B'." Voting power is vested only in Class "A," which accordingly is given preference in this respect over Class "B." Class "A" also has a dividend preference over Class "B," which is sold only to employees of the company. Customarily, however, common, or ordinary shares are all of the same class and represent the final equity in the enterprise after prior claims have been made. The simplest case of capitalization arises when a corporation has outstanding only one class of stock and no notes or bonds. The laws of some of the states specifically provide that in the absence of any special preference for certain classes of stock, all stock shall be of one class and shall be known as common stock. Any stock that is set aside and given special privileges has still all the rights of common stock, except so far as these are taken away or limited by statute or charter provision. 54. Special Forms of Shares There are many peculiar varieties of capital shares which do not come definitely within the two main classes, common and preferred, or which have notable features. In Great Britain it 1 See Book I, } 101; for discussion of shares without par value, see Book I, Chs. XIV-XVI. Ch. 5] COMMON STOCK 599 is a common practice to compensate the organizer of a corpora- tion by giving him a final claim on earnings which is valid only after all the claims of those who have furnished capital have been fully met. The shares which represent this claim are variously known as "founders' shares," "management shares," and "de- ierred shares." Although this practice is frequently con- demned, it seems at least as defensible as the custom in the United States in accordance with which the promoter of a cor- poration retains by way of compensation as much as he can of the common stock. 55. Founders' Shares 4 Deferred, management, or 'founders' shares in England are usually of very small par value most commonly, one shilling per share. In case the corporation succeeds in fulfilling the expectations of its organizer, the founders' shares may come to receive large dividends and to possess a high market value alto- gether out of proportion to their nominal value. Indeed, there are instances in which separate companies have been formed in order to hold the founders' shares and distribute interest in them in a more convenient manner. A slightly different plan was fol- lowed by the holders of the founders' shares in the original Suez Canal Company. There were TOO of these shares which were of no par value but which were entitled to 10% of the surplus profits. These 100 shares were divided into 100,000 and were sold on the open market. The customary arrangement is that founders', management, or deferred shares shall take one-half the profits remaining after the ordinary shares have received a given rate of dividend. Occasionally founders' shares are employed in this country, as was the case in the organization of the United Retail Stores Corporation, which issued 160,000 founders' shares without par value, which were sold at $5 a share to those identified with the management. Class "A" common shares were also issued and 4 See Book I, f{ 116, 117. 600 CORPORATE FINANCE [Bk. II- sold at $70 a share. The founders' shares ranked equally with Class "A" shares in dividend distributions. 56. Restrictions on Sale of Stock Sometimes voting shares are subjected to peculiar restrictions for the sake of forestalling any danger of losing control or of. bringing into the management people who are not desired. For instance, one of the English tobacco companies had but three or four hundred holders of its voting shares and was controlled by a much smaller number. In order to maintain its character as a close corporation, it stipulated in the articles of incorporation that no shareholder might dispose of his shares except by offering them, through the company, to other shareholders at a price to be fixed by the shareholders from time to time. An exception was made with respect to the transfer of shares to members of the immediate family of a shareholder. The price fixed for trans- fers was always considerably less than the probable market value. In the United States small, close corporations sometimes attempt to accomplish the same result by means of by-laws prohibiting the sale of stock to anyone not already a stockholder, or prohibiting the sale of stock without the consent of the direc- tors, or unless it has first been offered to the directors at a price not greater than that at which it is subsequently to be offered or sold to outsiders. These provisions, however, are illegal and unenforcible. Nevertheless they are sometimes adopted, and printed on the face of stock certificates to give notice that out- side purchasers are not welcome, and that whatever rights they may obtain they will be able to enforce only through legal process. Sometimes stockholders agree among themselves to withhold their stock from outsiders. Such a contract would be legal as be- tween the stockholders, but would not affect the rights of any out- sider who might purchase stock without notice and in good faith. 5 * See Book I, I 520. CHAPTER VI PREFERRED STOCKS 57. Nature of Preferred Stock Preferred stock is that which has some right or privilege not enjoyed by the ordinary or common stock. This preference us- ually takes the form of a prior dividend received by the preferred stock before any dividends may be paid upon the common stock. After payment of its preferred dividend, the preferred stock may participate further in dividends on prescribed terms, or it may be a non-participating stock which receives its preferred dividend and no more. Preferred stock may also have restrictions. The most com- mon of these is the deprivation of the voting right. Preferred stock may also have other features which are, or are not privileges according to the conditions and the point of view. For instance, preferred stock is commonly made redeemable at any time at the option of the company, or at some specified time. In either case, if the stock is a safe, dividend-paying stock and especially if it is a participating stock, this redemption feature detracts materially from its value. To offset this and make the stock attractive, the redemption figure is usually placed above par, as 105 or no, in some instances the redemption figure running up as high as 125. 58. Origin and Uses of Preferred Shares Preferred shares came into popularity in the United States chiefly on account of their utility in railroad reorganizations. It was and is still customary in severe reorganizations to cut down the fixed obligations of the corporation by compelling some of 1 See Book I, Ch. XI, "Preferred Stock"; for form of certificate see BookllV, Form 80. 601 602 CORPORATE FINANCE [Bk. li- the junior bondholders to accept preferred shares in exchange for their bonds. By making this exchange the former bondholders retain their claims upon the income of the corporation, but the claim is made simply a preference instead of a positive obligation. Except in reorganizations, preferred shares have been very little used in the United States by railroad corporations. The smaller corporations have also found preferred stock use- ful. One of the striking features of the stock market up to the time of the Great War was the successful floating of a large num- ber of preferred share issues by these smaller industrial corpora- tions. Sometimes the shares were sound, sometimes unsound. In either case it seemed to be fairly easy to dispose of them ; the buying public had evidently been educated to like and approve industrial preferred shares. The better securities at high rates issued during the war drove these low-grade issues from the gen- eral market. They are now gradually reappearing. Preferred shares are on rare occasions used to distribute vot- ing power in such a way as to give control to a comparatively small group. The preferred stock of the Allis- Chalmers Com- pany referred to later in the chapter is of this kind. In the incorporation of partnerships, preferred stocks are often used to make the necessary adjustments. If it is desired to give equality of voting right, the partner having an excess of capital is given a similar excess of stock in non-voting preferred stock. Or common stock may be given to those who have the management and non-voting preferred stock may be given to those who are outside. By means of the two kinds of stock with the different powers, privileges, and limitations that may be attached to preferred stock, almost any desired difference of in- vestment or power of control may be secured. 59. Preferred Dividends The preferred dividend may be either cumulative or non- cumulative. A cumulative dividend is one which carries over from year to year; that is to say, in case the profits are not suffi- Ch. 6] PREFERRED STOCK 603 cient to pay the full preferred rate in any given year, the unpaid dividends will remain as a prior claim to be paid in some succeed- ing year before dividends are declared on the common shares. Non-cumulative dividends give the preferred shares a prior claim for dividends each year; but in case these profits are not suffi- cient to meet the claims, or for other reasons dividends are not declared, no obligation rests upon the corporation to make up the deficiency in later years. 60. Non-Cumulative Dividends At one time most preferred shares were non-cumulative. But the non-cumulative feature has been found unsatisfactory be- cause of the conflict of interest between the common and the preferred shareholders as to the payment of preferred dividends each year. It is entirely in the discretion of the directors to de- cide whether or not the preferred dividend shall be paid. It is obviously to the advantage of the common shareholders whom the directors more directly represent to defer dividends on such preferred shares as long as possible, since the cumulating profits are usually lost forever to the preferred stock and inure directly to the benefit of the common stock. It is a simple mat- ter of accounting procedure to pass the profits of the corporation to increase surplus or perhaps to expend them in activities not immediately productive, as the establishment of a new magazine, or the introduction of a new product, and ignore preferred divi- dends entirely until sufficient profits have accumulated to pay dividends to both common and preferred stock. And these divi- dends may be large for the common stock but small for the pre- ferred stock considering the number of dividends it has missed. Obviously, there is plenty of opportunity for unfair diversion of funds when preferred dividends are non-cumulative. 61. Effect of Non-Cumulative Preferred Stock Non-cumulative preferred stock is, in fact, a standing invita- tion to the directors, unless their ethical standards are high, to 604 CORPORATE FINANCE [Bk. II- administer the corporate finances to the advantage of the com- mon stockholder. As stated, profits that might very properly have been applied to the preferred dividends are diverted into improvements or developments. These redound to the ultimate advantage of the company, but meanwhile stand in the way of dividends on the non-cumulative preferred stock until the com- pany has reached a point where common and preferred stock dividends are both possible. The preferred stockholder's divi- dends for this period are absolutely lost as far as he is concerned. The company has profited at his expense. The directors might properly have paid them if they would, but decided in favor of the common stockholder. If investors were wise there would ordinarily be no sale for the non-cumulative stock, for there is no legal way for the holder of such stock to prevent the directors postponing dividends until the common stockholders can share equally or even receive more than do the holders of preferred stock. On the other hand, it must be admitted that when issued by a strong company with an honest administration, a non-cumula- tive preferred stock may be very satisfactory. Such a stock is the 6% non-cumulative preferred stock of the International Nickel Company which has received its full dividends since 1906. Another similarly desirable non-cumulative preferred stock is that of the American Car and Foundry Company, which has re- ceived its 7% f preferential dividend regularly since the organiza- tion of the company in 1899. Even better is the record of the American Cotton Oil Company which has paid a 6% dividend regularly upon its non-cumulative preferred stock since 1892. Unhappily for the record this dividend was deferred June i, 1921, for the first time in the history of the company. It is to be noted that if the preferential dividend is to be non- cumulative, this fact must be clearly expressed in the formal provisions by which the stock is authorized. Where not so ex- pressed the courts have held the preferential dividends to be cumulative and payable in full out of the first profits before any- Ch. 6] PREFERRED STOCK 605 thing is received by the common stock. The cumulative feature of preferred stock is, however, for the sake of security and defi- niteness usually covered by express provision. 62. Cumulative Dividends Cumulative dividends, on the other hand, have an uncom- fortable habit of piling up, and may become in the course of a few years so serious a burden as to leave no reasonable hope for dividends on the common shares. Such a situation might inter- fere with, or prevent entirely, additional financing were it needed. It is not at all uncommon in corporate experience for a company to go through several years of depression and limited income, and then, through good management or by some fortunate circum- stance, suddenly enter upon a period of prosperity. Naturally, the common shareholders, having received no dividends through the lean years, feel that they are entitled to some recompense. If a large amount of unpaid dividends on cumulative preferred shares stands in the way, it is now customary to try to find some way, under the conditions stated, of "funding" these unpaid dividends, thus satisfying both the common and the preferred shareholders. The funding of the unpaid dividends is usually ac- complished by issuing securities of some kind to the preferred shareholders in exchange for their dividend claims. Thus in the readjustment of the capitalization of the Interborough-Metro- politan Company in 1915, the holders of the 5% cumulative pre- ferred stock on which a considerable amount of dividends had cumulated, were given, in consideration of their surrender of these cumulated dividends, a new 6% non-cumulative preferred stock of the Interborough Consolidated Corporation. 63. Rates of Preferred Dividends Although preferred shares are entitled only to what is spe- cifically granted to them, some customs have become fairly well established. In the United States nearly all industrial preferred shares bear cumulative dividends. Before the Great War these 606 CORPORATE FINANCE [Bk. II- rates ranged from 6% to 8%, the great majority receiving 7%. During the time of the war the prevailing dividend rate rose to 8% and has since remained there. Just why these percentages should have been chosen is somewhat difficult to say. Probably the best answer is to be found in the statement that high-grade preferred shares have been selling for several years on about an 8% basis ; that is to say, if they are 7% shares they sell at about $87.50 for each $100 share; if they are 8% shares they sell at about par. Inasmuch as shares, when they have a market value of or near par, are more convenient and more salable than would otherwise be the case, there is an advantage in making their preferential dividend 8%, or whatever the rate may be that will sell the stock at par. 64. Participation Rights of Preferred Shares Unless otherwise expressly provided, preferred stock partici- pates equally with the common stock in all dividends after both common and preferred have received an equal dividend. That is, if the preferred stock has received its preferential dividend of, say, 8% together with any cumulated arrearages, it participates no further in dividends until 8% has been paid upon the common stock as well, but thereafter both classes of stock stand upon exactly the same basis as to any further dividends declared dur- ing that year. If such further participation on the part of the preferred stock is not desired, it must be expressly denied. In such case the charter usually contains a provision prohibiting such participation, and the preferred shares then receive their fixed dividends, and no more. The usual preferred stock does not participate in profits be- yond its fixed rate, but there are numerous exceptions to this rule. For instance, in one remarkable case, that of the American Brake Shoe and Foundry Company, until recently 7% was paid on the preferred shares, 7% on the common shares, and the pre- ferred shares were then entitled to all additional earnings. The Westinghouse Electric and Manufacturing Company's preferred Ch. 6] PREFERRED STOCK 607 has a prior claim to 7% and, after the common has received 7%, shares equally with the common in any further distribution. The Chicago and Northwestern Railway's preferred stock is entitled to 7%, to be followed by 7% on the common; then the preferred is entitled to an additional 3%, and thereafter if profits permit the common receives a similar amount. After this, both stocks participate equally in any further dividends. In 1920 the preferred stock received 7%, the common 5%. American International Corporation preferred participates equally with the common stock until both have received 7%, thereafter the preferred receives one-fifth of any additional amount declared in dividends that year, the common stock re- ceiving the remainder, 65. Preference as to Assets Shares may be preferred not only as to dividends, but also as to assets; that is, in case of dissolution or insolvency, the full par value of the preferred shares is to be paid before any payment is made on account of the common shares. We shall see, when we come to consider reorganization, that as a matter of fact going corporations are seldom sold or entirely liquidated and the assets distributed among the various security holders. It is usual to bring about a reorganization in which the claims of each class of securities are so readjusted that they may all be met by the cor- poration. Hence the prior claim of preferred shares upon assets is not to be taken too literally, but is to be regarded rather as a legal point of advantage in securing the best possible terms in case reorganization should become necessary. From this point of view, the preference as to assets is of considerable importance. The preferred stock of industrial corporations is almost in- variably preferred as to assets. 66. Voting Rights of Preferred Stock Preferred stock has the same right to vote as has the common stock unless the right is specifically denied. Usually it is denied, 608 CORPORATE FINANCE [Bk. II- or is given in some restricted form. Thus a protective feature given by many companies is the proviso that the preferred share- holders shall automatically obtain control, or partial control, over the directorate of the corporation in case their dividends are not paid. It is also customary to give the preferred the power to veto an increase of bonds or of preferred stock. The Wisconsin Central Railroad Company provides that in case of failure for two successive years to pay 4% dividends on its preferred, the preferred shareholders shall have the right to elect a majority of the directors. In the American Smelters Securities Company the preferred shareholders are permitted to vote if dividends for one year remain unpaid. The William Carter Company gives both the preferred and. the common shares equal voting power, except that if there is default in four successive quarterly divi- dends on the preferred, or if the net quick assets are for one year less than the par value of the preferred shares outstanding, the preferred becomes the sole voting stock. The American Sumatra Tobacco Company provides that if unpaid dividends accumulate above 14%, the preferred shareholders shall have the right to elect a majority of the board and shall continue to have such right until all accrued dividends have been paid. The American Rolling Mill Company gives its 6% preferred stock the right to vote only when four successive dividend periods have been passed. All of these provisions appear to be equitable, although the mere grant of voting power to preferred shareholders, if the common shares still retain control of a corporation, may prove to be a concession of only slight importance. If it is expected and seriously intended that the dividends on preferred shares shall be paid regularly year after year, then it would seem only fair that the common shareholders, if they fail to live up to this expectation, should forfeit control and give the preferred share- holders a chance to see what they can accomplish. While preferred stock has every right of common stock that is not expressly denied, it is well to reiterate that, on the other Ch. 6] PREFERRED STOCK 609 hand, the preferences granted to preferred shares are no more than are distinctly specified, and that these preferences may con- sist not only of prior claims as to dividends and assets, but even of prior claims as to voting. For instance, the preferred shares of the old Rock Island Company of New Jersey (the former hold- ing company for the Chicago, Rock Island and Pacific Railway) were entitled to elect a majority of the directors of that company. At the present time the preferred stock of the Allis- Chalmers Manufacturing Company has the voting power and is entitled to elect a majority of the board of directors. 67. Redemption of Preferred Shares It has already been noted that in modern corporations the distinction between owned capital and borrowed capital is some- times shadowy. Preferred shares, for instance, are sometimes protected and subject to redemption in such a way as to bring them almost, if not wholly, into the same class as junior bonds. It is very common practice for a company to reserve the right to redeem preferred shares, usually at a premium varying from 5% to 25% or more. The decision of the matter, however, rests with the corporation. Further than this, many companies make redemption obligatory and even provide for the building up of sinking funds for this purpose, just as in the case of sinking fund bonds. The California Petroleum Corporation, for example, has set aside 5 cents on each barrel of petroleum sold, to redeem its preferred shares, which are subject to call at any time after three years from date of issue, at 120. The Studebaker Corporation and the Underwood Typewriter Company both have sinking funds for this purpose. There are a number of provisions concerning the redemption of preferred shares, that are worth noting. The General Asphalt Company has outstanding $7,541,100 5% cumulative preferred which is convertible into common at any time on even terms, in addition to which the preferred shareholder will, for each share exchanged, receive a bonus or premium of $50 of common stock; 6 10 CORPORATE FINANCE [Bk. II- that is, for each single share of preferred stock he turns in, he will receive a share and a half of common stock $150 of common stock for each $100 of preferred. As to the rate of redemption, the Fisk Rubber Company has an unusual provision to the effect that in case of forced liquida- tion the preferred stock is entitled to par and accrued dividends, but in case of voluntary liquidation it is entitled to 110% of par and accrued dividends. The preferred stock of the Studebaker Corporation may be called at 125, and the preferred stock of the Underwood Typewriter Company and of the F. W. Woolworth Company may be redeemed at the same figure. 68. General Protection of Preferred Stock It is also becoming a more and more prevalent custom to protect preferred stock by specific provisions as to ratio of cur- rent liabilities to current assets, of net surplus to capital, of divi- dends to current surplus, and the like. The Stollwerck Choco- late Company, for instance, may not pay any dividend on its common stock until the net quick assets are equal to 75% of the first preferred stock outstanding, and may not pay dividends on the common stock in excess of 5% until the net quick assets equal the full face value of the outstanding first preferred stock. Montgomery Ward and Company, Inc., provide that no addi- tional preferred beyond the present issue can be put out unless, after such issue, the net quick assets shall equal at least 120% of the outstanding preferred. The Griffin Wheel Company has a number of detailed provisions. Additional issues (after the original issue) of its preferred stock cannot be put out up to more than 66%% of the cost of improvements, extensions, or increased working capital. Common dividends may not be increased to more than 7% unless the net tangible assets are at least 150% and net quick assets 50%, of the preferred shares; even then the common may get only one-half the surplus earnings above the preferred and previous common dividends. When the tangible assets rise to 200%, the net quick assets being 50% of the pre- Ch. 6] PREFERRED STOCK 611 ferred, the directors of this company may declare such dividends on the common "as may be deemed prudent." 69. General Characteristics of Preferred Shares From the various examples that have just been cited, the reader may construct a composite picture of preferred share issues. He will find that they range in their fixed dividend rate from as low as 6% to as high as 10%, with a marked preference among industrials for 8%. He will find that of the older pre- ferred stocks, a great majority either are irredeemable or are redeemable at the option of the corporation, so that they are not obligations of the issuing corporation; and that a small but in- creasing number of the more modern preferred stocks are pro- tected by sinking funds and by other provisions which make them, for all practical purposes, definite obligations of the corporation. In every case in which preferred shares are under considera- tion, it must be remembered that shares may be preferred in a great many different respects and forms, and that it is therefore necessary to study each instance of preference separately. This is well illustrated by the struggle in IQOI between the Hill- Morgan party on the one side and the Harriman-Kuhn, Loeb party on the other, for control of the Northern Pacific Railroad Company, in the course of which the Hill-Morgan party secured a majority of the common shares, and the Harriman-Kuhn, Loeb party a majority of the preferred shares together with enough of the common shares to give them a majority of the en- tire outstanding stock. Inasmuch as both common and preferred shares had voting rights, it seemed clear that the victory remained with the Harriman-Kuhn, Loeb group. Unfortunately for their calculations, however, the charter of the company gave the com- mon shareholders a right which had apparently been overlooked by their opponents to redeem at any time the preferred shares at par. This right the Hill-Morgan party exercised and, through the preponderance thus given them, obtained control of the road. CHAPTER VII BONDS 70. Corporate Borrowings 1 There is no distinction between the method of a private loan made by an individual, by a partnership, or by a corporation. The usual evidence of the debt in any of these cases is a note, and the general form of the note given by a corporation is the same as that given by any other borrowing concern or individual. When, however, we come to the public loans so characteristic of corporate financing, this is no longer true. The instruments by which the debt is evidenced are still notes in form, but of a form peculiar to the corporation the short-term note and bond. Both these are, as stated, notes, but differ from the ordinary "bankable" notes made by the same corporation in the longer time for which they run ; in the fact that while the total amount is large, the notes making up this total are of comparatively small face value; in the method by which they are secured; and generally in the formality of their issue. 71. Long-Term Loans There is a fundamental difference between short-term and long-term borrowing. While they tend in certain isolated cases to merge into each other, the distinction is for practical purposes clearly marked. The simplest form of long-term or "funded" borrowing is the ordinary mortgage on real estate, or, as it is sometimes called, the bond and mortgage. The form of this instrument is almost as ancient as law itself. It purports to be a transfer of the title to a piece of real estate from the former owner to a new owner, i See Book I, Chs. LIV, LV, "Bonds"; also Book IV, Forms 250-253. 612 Ch. 7] BONDS 613 with the proviso, however, that the title may be redeemed by the former owner on repayment, at maturity, of an acknowledged debt which he obligates or "bonds" himself to repay. Although this is the immemorial form, the instrument does not, as a matter of practice and of legal interpretation, actually convey ownership of the property cited; its effect, in spite of the wording of the mortgage, is merely to pledge the property as security for the repayment of the loan. There are varying forms of the bond and mortgage in the different states which may not be covered in all their details by the description given above, but the essen- tial characteristics of these bonds and mortgages are the same in all cases. The bond and mortgage is used ordinarily for relatively small amounts. It is the favorite form under which individuals who own farms, city real estate, and other property, raise long-term loans secured by this property. It is frequently used also by smaller partnerships and corporations. But there are, of course, some obvious drawbacks to this form. In the first place, it is necessary for the mortgagor to find someone who is willing to invest the whole amount named in the bond in a lump sum. This may not be difficult so long as the sum is small. Mortgages are very commonly taken by savings banks and other institutions, as well as by individuals who reside in the neighborhood of the property mortgaged and therefore are acquainted with it and at the same time are able and willing to advance the sum of money that is required. Within recent years there has been a concerted and successful effort to extend the market for farm mortgages, and brokers and land mortgage companies operating in the agricultural states of the West have built up successful businesses in selling mortgages, and bonds based on mortgages, direct to investors in the eastern states. Also the federal land banks and the national farm loan associations together with the joint-stock land banks, all agencies authorized by Con- gressional action and operating under federal supervision, have come to the relief of the farmers and, by means of bonds based 614 CORPORATE FINANCE [Bk. II- on farm mortgages, have enabled them to borrow even more advantageously than the large corporations. rh.'.'1'.nii!/. .'n.n3 ,biiBl THE FINANCIAL PLAN 166. Adaptation of Securities to Market In previous chapters the principal forms of security issues common and ordinary shares, preferred shares, income bonds, debentures, collateral trust bonds, mortgage bonds, and the like have been described. The point has been emphasized that, while there are favored and popular forms of security issues, there are no invariable forms. Some kind of a security issue can be found that will suit both the taste and the pocket- book of anyone who has capital at his disposal. The financial manager of a business enterprise will naturally make such adaptations of the securities he has to offer as will best fit them for the market he is trying to reach. If his prospective pur- chasers are people of small income, he may find it best to issue shares of a par value of $5 or $10, instead of the conventional $100. On the other hand, if he is getting out a note issue ex- clusively for sale to some of the big institutions, he will perhaps give his notes a par value of $10,000 or even $100,000. He will also pay reasonable attention to passing fashions or popular interests. In one year convertible bonds are much talked about and easily sold. In another year the popular interest is centered largely on industrial preferred shares. In another year there is, it may be, an unreasoning aversion to collateral trust bonds. Any successful seller of securities will carefully study these fashions and whims on the part of the investing public. In choosing forms of securities, unfamiliar financial devices are usually to be avoided unless perhaps they are brought for- ward by some individual or corporation with great prestige. The financial conditions at the time the security is brought out 720 Ch. 17] THE FINANCIAL PLAN 721 must also be carefully considered. Thus during the period of the Great War short-term securities were issued in great quantities, partly because there was a public preference for such notes and partly also because it was hoped that interest rates would fall and thus make the conditions more favorable for long-term issues. The wisdom or unwisdom of this course need not be considered here. The point to be made is that the large corporations have been consciously endeavoring to adjust their security issues to current conditions in the security market. in lip;. If ' "; '* &*'* &>nJ * H<< 167. Results of an Ill-judged Issue A striking example of very poor judgment in trying to make this adjustment is found in the history of the ill-fated Cordage combination. In December of 1892 the common stock of the combination was selling at $142 a share and the standing and reputation of the company was high. In January a stock divi- dend of 1 00% was declared, increasing the common stock from $10,000,000 to $20,000,000. In April, 1893, the company had an inventory consisting of between $5,000,000 and $6,000,000 of binder twine, against which it had borrowed upward of $5,000,- ooo from New York and Boston banks in the form of demand loans and short-term paper. While it was in this difficult condition the crisis of 1893 became more and more threatening and some of the bankers notified the company that the loans must be taken up at least in part on maturity. On Friday, April 28, 1893, the shares of the National Cordage Company were selling at excellent prices, the preferred at 103^4 and the common at 61, and the credit of the company was high. The following morning at a special meeting of the board, it was decided to take care of the demands of the banks by an immediate offer to the common shareholders of $2,500,000 of new preferred shares at par. This was equiva- lent to giving the common shareholders a privileged subscription of some slight value. Under ordinary conditions there would have been little doubt as to its success. But the conditions were 722 CORPORATE FINANCE [Bk. II- not ordinary. The action of the board was interpreted in the light of the general feeling of suspicion and uncertainty as to the soundness of all corporations; a bear party attacked the Na- tional Cordage Company's shares and within the day the market price of the preferred stock fell to less than par and that of the common to less than 50; two days later the preferred had gone down to 83 and the common to 36. Under such conditions it was, of course, out of the question to make a success of the preferred stock issue. The next day the common stock fell to $18.75, the banks became alarmed and demanded immediate and full repayment, and the company sud- denly collapsed. It was one of the most surprising and spec- tacular insolvencies to be found in the financial history of the country. Undoubtedly the National Cordage Company was in unsound financial condition at this time, but the immediate cause of its collapse was the imprudence of the directorate in failing to give due consideration to the general market condi- tions. 1 Every possible measure should be taken to meet the conven- ience of prospective purchasers in putting out security issues; for instance, large corporations which enjoy an international market frequently make interest payable at the principal cities of the various countries in which the bonds are likely to be sold. There are a number of bonds issued in this country the interest on which may be collected in Paris, London, Berlin, or New York. On the other hand, the interest and also the principal of most of the recent external loans of the governments of Europe are payable in this country and in its currency. 1 68. Adaptation of Securities to Corporate Conditions Up to the present point we have considered only the relations between security issues and the needs or desires of the prospec- tive purchaser of these issues. It is, of course, clear that there must be a correspondence also between the security issues and i Dewing on Corp. Prom, and Reorg., p. 112 el seq. Ch. 17) THE FINANCIAL PLAN 723 the financial condition of the corporation. The mere fact that a security of a given type is thought to be easily salable is not always the final reason for issuing just that security. The cor- poration's interests may best be served by some other type of security, and it may be necessary in fact, generally is necessary to make a compromise. From the corporation's standpoint, the outstanding securities should be in correct relation both to the assets of the corporation and to its earnings. If this correct relation or an approxima- tion to it is not secured, then one of two undesirable results must follow: either the capital required is secured upon terms that are more or less onerous and wasteful, or, on the other hand, the corporation is burdened with claims which it may not be able to meet and which therefore endanger its continued exist- ence. The first-named fault is probably both less frequent and less to be condemned than the second fault. 169. Adjustment between Common Stock and Prior Obligations There are some corporations, which have actually caused unnecessary sacrifices to their stockholders by reason of a blind adherence to the policy of putting out only common stock. If a public utility company, for example, were to attempt to finance itself solely by the sale of common stock, the chances are that there would be very little money for anyone interested. The profits on such enterprises are comparatively limited, and the financing must be watched with the closest attention in order to preserve reasonably good earnings for the benefit of the common shares. This can be made clearer by a hypothetical case than by any example which is at hand, for practically all public utility companies do raise the greater portion of their capital through issuing obligations rather than through issuing shares. Let us suppose that a public utility corporation requires $10,000,000 capital, and that its net earnings amount to $700,000, or 7% on the invested capital. Clearly this would not in itself be an attractive return to prospective purchasers of the common stock. 724 CORPORATE FINANCE [Bk. II- Let us further assume, however, that $6,000,000 of the required capital is secured by bond issues at an average cost to the cor- poration of 6%; that $2,000,000 is obtained through preferred stock or junior bond issues at an average cost to the corporation of 8%; and that $2,000,000 is obtained by the sale of common stock. In that case the annual profits would be distributed as , ,, follows : Bonds, $6,000,000 at 6% $360,000 Preferred stock, $2,000,000 at 8% 160,000 Common stock, $2,000,000 with earnings of o% 180,000 Total earnings $700,000 As a matter of fact, it is customary to provide all the cost of the tangible property of public service enterprises by issuing bonds up to about 75% of the cost, and preferred stock or junior bonds up to about 25%. The common stock in this case repre- sents intangible assets or earning power and is retained by the promoters of the enterprise as their profits. If this rule were followed in the case just cited, the results would be as follows : $7,500,000 bonds at 6% $450,000 $2,500,000 junior bonds at 8% 200,000 Available as earnings on common stock. 50,000 Total $700,000 170. Relation between Income and Security Issues It would be useless to give illustrations at this point of cor- porations which have transgressed the limits of prudence in sell- ing their obligations to the public, for such cases are dealt with in the later chapters, where financial embarrassments, insol- vencies, and reorganizations are discussed. It is obvious, on the face of it, that a corporation, like an individual, may abuse its credit. The rule of safety in the issuance of funded obligations requires that the corporate income shall at its minimum not only cover the fixed charges, including both interest payments and sinking fund payments if any, but leave a safe margin beyond Ch. 17] THE FINANCIAL PLAN 725 tliis. The rule of prudence, when securities such as income bonds are issued which carry a contingent liability, is that the cor- porate income over and above all fixed charges must be ample under all conditions that can reasonably be anticipated, to cover these contingent charges. The rule of good faith in connection with the issuance and sale of common stock requires that the anticipated income, based upon the probabilities, should be ample to provide in addition to all fixed and contingent charges a reasonable and increasing return on the common shares. We may state this relation as follows: 1. Assured net income should be more than enough to meet all fixed charges on funded obligations, including inter- est and sinking fund payments. 2. Additional income anticipated beyond reasonable doubt, should be more than enough to cover any contingent charges. 3. Additional probable income should be more than enough to provide a satisfactory yield on common shares. ' It is true, of course, that unforeseen occurrences frequently wreck even the soundest and most careful estimates, and that the organizers and financial managers of corporations are not always entitled to censure because their plans miscarry. They are clearly entitled to censure, however, if they do not make their estimate of future income with reasonable foresight and conservatism, and if, after having procured sound estimates, they fail to observe the relations above referred to between earnings and security issues. 171. Relation between Assets and Security Issues The assets of every enterprise fall into three natural divisions : 1. Fixed tangible assets, which represent a permanent in- vestment essential to the conduct of the business. 2. Current assets, which consist of cash and of such property as can readily be converted into cash. 726 CORPORATE FINANCE [Bk. II- 3. Intangible assets, which, as previously defined, are the capitalization of the earning power which cannot be attributed to the other assets. There is a relation between these classes of assets and the security issues of a corporation, which may be stated in the fol- lowing form : The actual value of fixed assets (not merely the book value) should exceed by at least 25% to 50% the bonded obligations outstanding. The actual value of the fixed assets, plus the value of net current assets (after deduction of current liabilities) should at least equal, and generally considerably exceed, the outstanding preferred shares, income bonds, or other contingent obligations. The actual value of tangible assets, plus that of intangible assets, should equal or preferably exceed, the combined value of fixed obligations, contingent obligations or shares, and common shares outstanding. 172. Common Stock to Represent Intangible Assets Quite a large number of industrial corporations have followed the principle of issuing bonds and preferred shares up to the full net value of their tangible assets, and then issuing common stock up to the value of their intangible assets. Cluett, Peabody and Company, the well-known manufacturers of collars and shirts, carry an account called "Good-will, Patent Rights, Trade- Names, etc.," of $18,000,000, against which the corporation had outstanding up to 1920, $18,000,000 of common stock. In 1920 this common stock was increased to $18,275,000. The F. W. Woolworth Company has good-will $50,000,000, and common stock now $65,000,000, but up to 1920, exactly $50,000,000. The George A. Fuller Company, later consolidated with the United States Realty and Improvement Company, at the time of its incorporation presented a balance sheet showing net quick Ch. 17] THE FINANCIAL PLAN 727 assets of approximately $5,000,000, and "Tools, Machinery, and Good-Will" of $10,000,000; against this, $5,000,000 of preferred and $10,000,000 of common stock were issued. In most cases the correlation between the different forms of securities and the three classes of assets is not so direct and readily visible. But there is, or should be, some measure of relation. The possibilities in this direction have, though, been somewhat interfered with in late years by the provision of the Federal Excess Profits Tax Law, limiting the valuation of intangibles to "25 per centum of the par value of the total stock or shares of the corporation outstanding at the beginning of the taxable year." 2 173. Special Forms of Securities As has been previously stated, there are many forms of securities issued. The more important types have been de- scribed in previous chapters, but a few examples may be cited here of instances in which unusual changes were made in order to adapt the security to peculiarities in the assets or in the mar- ket conditions. English practice runs very strongly toward the the issuance of perpetual or irredeemable debentures, the idea being that all the debtor cares for is to have his interest paid regularly, thus giving him a security which is readily marketable. Even the large brewing companies in England, which can hardly be thought to have a business that is beyond all human vicissi- tudes, have nevertheless issued and sold a large number of these perpetual debentures. In this country perpetual bonds are almost unknown, though there are a few issues, such as the Lehigh Valley Railroad's Consolidated "Annuity" bonds, which have no redemption date. In the United States participating bonds are occasionally brought out when it is desirable to make an issue unusually attractive, as in the case of the 6% Debenture Gold bonds of the Beneficial Loan Society of New York, where each purchaser 2 Excess Profits Tax Law, Sec. 326a, Subdiv. $. 728 CORPORATE FINANCE [Bk. II- receiyes a profit-sharing certificate which entitles him to a share in the profits of the society on a prescribed basis as long as his bond is outstanding. Of a similar nature are the 7% Par- ticipating First Mortgage Guaranteed lo-Year Gold bonds of the Eastern Limestone Corporation of New Jersey, where each year 20% of the net earnings of the company, after deducting sinking fund requirements, are to be distributed to the holders of these bonds. Other devices of a somewhat similar nature to make securities attractive are not uncommon, as where a land company makes its bonds or stock redeemable in land at the option of the holder. Recently a Florida company, organized to prospect for oil on its 13,000 acres of land, offered ''certificates" for sale which in case the company did not strike oil might be exchanged for "citrus- growing" land. An even more peculiar security was brought out by a large distilling company before the days of national prohibition consisting of a preferred stock issue which was to be redeemed by the corporation and was secured by a first lien on all the whiskey stored in bond. The holder of a share of preferred stock could, however, if he chose, take a barrel of whiskey in payment, of his claircu Even this ingenious arrange- ment, it is understood, did not bring about the success of the issue. 174. Haphazard Financing There is very little real planning in the financial development of most corporations. The easy and obvious thing to do is to meet each financial difficulty or problem as it comes along, in the hope that there will be no further problems. Frequently the result is to create a maze of conflicting claims, and to impose obligations upon the corporation which seriously interfere with the normal growth of its credit and lead to loss or even to in- solvency. Many of the financial troubles which come to concerns that are fundamentally sound and prosperous are wholly unnecessary. Ch. 17] THE FINANCIAL PLAN 729 They could be avoided by a moderate amount of foresight and careful planning. A typical instance is that of a knitting mill in an eastern state which is capitalized at $900,000, $600,000 com- mon and $300,000 7% cumulative preferred stock. The quick assets are $450,000 in excess of its quick liabilities, and the com- pany has a surplus of $500,000. This corporation, like most textile concerns, borrows heavily from the banks. It seldom has loans of less than $600,000 outstanding, and frequently they rise to $900,000; the loans are obtained at an average rate of 6%. The question that has been raised and is now under con- sideration, is whether it would be desirable to put out an addi- tional $300,000 of 8% preferred stock at par, thus cutting down the bank borrowing. :>. ;: ,/i; iiU^boeml aid \o w'ri'jsqeyni. > ^JfJnn:.) 1 ^. to uke yjtft yd !/juiu;!r.n 204. Preliminary Financing As soon as a promoter starts to develop a new proposi- tion, he begins to establish if he has not previously done so the banking connections that will be of greatest use in con- nection with the enterprise. These connections should be with banks that are already familiar, through their own experience, either with the line of business or with the field of operations of the business in which the promoter is working. To be specific, if the project is to establish an interurban railroad near Dallas, Texas, the promoter will look for his financial connections either among the New York, Boston, Chicago, and St. Louis banking houses that are accustomed to investigating and floating inter- urban properties, or among the Dallas bankers who thoroughly know the local situation and can perhaps assist in raising funds from local people. The active co-operation of interested bankers is quite essential to the success of most promotions. The first stage of the financing in which the banker plays his part may be reached when the purchase of options or the outright purchase of property is under consideration. The bankers interested may, at this point, create a syndicate which will advance money to the pro- moter for the purchase of options on the property, with the agree- ment that repayment is to be made as soon as the promotion is successfully floated. If the expenditure at this stage is for options only and the promoter's personal means do not allow him to go ahead unassisted, he will very likely attempt to organize a small syndicate among personal acquaintances who are willing to share with him equally the risks and the profits of the pro- 765 766 CORPORATE FINANCE [Bk. II- motion. Ordinarily the bankers would not step in unless out- right purchase on a large scale was called for. The next stage at which bankers' co-operation may be called for is during the period of development, when the promotion involves a great deal of construction; or the period of waiting, when the promotion is a combination that cannot at once be financed by the sale of securities to the public. Let us take an assumed example for the sake of clearness. A new manufacturing company is to put up a plant costing $1,000,000, and provide machinery and equipment amounting to $500,000. Let us as- sume that the product is of such nature that there can be no question as to its marketability. It may sometimes be desirable and possible to raise the full amount of required capital $1,500,000 in this case at the outset, and expend it gradually in the construction of the plant; but in other cases this plan will be found impracticable and the question will arise as to how to secure the funds with which to keep construction going while at the same time taking care of the sale of securities. The customary plan is to place a mortgage on the property acquired, and to issue bonds to the extent of the mortgage. These bonds, however, will not be salable until the property has actually been developed. The difficulty may best be met by depositing them with bankers as security for short-term loans and using these loans for construction. The banker receives the bonds as collateral, which will eventually be salable, and in case the whole proposition is sound, he may consider himself at least fairly well protected. Usually the arrangement is that the bonds shall be delivered as construction goes on, so that the banker may never have on hand bonds representing property that exists as yet only on paper. The analogous difficulty in case a combination is formed, the securities of which are not at once salable, is met in the same way. The securities are posted as collateral for bank loans and the loans are later paid off as the securities are dis- posed of. Ch. 20] PROMOTION METHODS OF FINANCING 767 By means of this preliminary financing, an enterprise can be financed, even though the promoter and his immediate friends have limited funds, up to the point when the sale of securities to the public brings in the required amount of capital. 205. Plan to Raise Capital for a Factory l The following interesting and successful plan of raising money for cotton mills is described by Daniel Augustus Tompkins, "ABuilderof theNew South." The same method of raisingmoney could be utilized with equal success in many other directions. There are in successful operation in the southeast a number of cotton factories built by money raised on the instalment plan as the payments are made in a building and loan association. The writer had observed that in many towns there was a strong desire among the people to build and operate a cotton factory, but they conceived it impossible to raise the capital at home because, as a rule, few people in towns or small cities have much unemployed capital. It was further observed that in almost if not quite every one of these instances one or more building and loan associations were in opera- tion with accumulated cash in excess of what was considered pos- sible to raise for the construction of a cotton factory. The con- clusion was therefore reached that if a plan could be formulated by which a company could be organized whose capital stock was made payable in the shape of regular weekly or monthly saving, then any ordinary community could raise the money to build a factory. Following out this line of thought it was found that with shares of one hundred dollars par value they could be paid in full as follows: 1. At the rate of one dollar per week per share the par value would be reached in a little less than two years. 2. At the rate of fifty cents per week the time would be a little less than four years. 3. At the rate of twenty-five cents per week the time would be a little less than eight years. AH of these plans of pay- ments have been tried at Charlotte, North Carolina, and in every case the result has been successful. . . . On the basis of subscriptions aggregating one hundred thousand 1 By permission of Doubleday. Page & Co., from "A Builder of the New South, Daniel Augustus Tompkins," by George Tayloe Winston. 768 CORPORATE FINANCE [Bk. II- dollars there would be paid the company each year about twenty- five thousand dollars. With this amount of money the buildings could be constructed and paid for in the first year. Within the second year, one- third of the machinery could be purchased and put in operation. In three years from the time of organization it would be usually possible to have the entire plant in operation with some debt, which could be paid off as the instalments were paid in the last year. . . . It goes without saying that the quickest time in which the capital can be accumulated is the best. If subscriptions can be procured on a basis of two dollars a week per share, thus making the capital payable in about a year, this would be the next best thing to having the money subscribed subject to call as it might be needed. Next to the rate of $2.00 per week the one dollar per week would be desirable. Then follows fifty cents a week and twenty-five cents per week. The last-named rate, while it has been proven practicable in the case of a few mills, is undesirable if the subscriptions can possibly be got to fifty cents per week or more. The plan of fifty cents per week has been the most popular one, and it has in ah 1 cases worked well, the result having been dividend- paying manufacturing plants. The completion of a mill may always be hastened beyond what could be done with ordinary income by borrowing money to com- plete the mill at once and then paying this money back as it is paid into the treasury in instalments by the stockholders. Wherever this has been done the mill company has commonly made notes which have been made secure by indorsement of the directors. For this reason it is desirable to have a board of directors whose re- sponsibility is well known. Some of the mills have been built, however, simply by investing the money as it came from the members; and while this is some- what slow, yet when the mill is finished and in operation, it is usually so much property ahead for the stockholders for it fre- quently represents money that would not have been accumulated at all, except for the obligation of the stockholders to get together and save so much money each week or month. . . . The preliminary preparation for the organization of such a company in the way of preparing the right kind of charter, by-laws and subscription list, should be left to the engineer selected to make plans and guide the company in the conduct of its affairs. Ch. 20] PROMOTION METHODS OF FINANCING 769 It is very important for a company of inexperienced people to select a good engineer and then rely upon his knowledge, skill, and judgment. Any attempt to build a mill without good counsel will be troublesome. Advice picked up here and there, free of charge, is worth just what it costs, viz., nothing. A good engineer will charge a good fair price, and will handle the matter just as a good lawyer would a law-suit or as a physician would handle a case of sickness. There are numbers of good engineers in the country whose records for successful work become a guarantee for the success of whatever they undertake. . . . In one or two cases another feature has been introduced, viz., subscribers give notes for the amount of their subscriptions. By this plan the company has the notes to use for collateral in case of borrowing money; and if the notes are made interest-bearing then the burden of interest falls on the subscribers and not on the treasury of the company. . . . The factories built with capital raised on the above plan have all been successful, and are now doing well. 206. Necessity for Adequate Financing One of the most common errors and also one of the most dangerous in organizing a new corporation is to start it off with insufficient capital to carry it through to success. The result is that the new corporation perhaps makes a fine start, gives promise of yielding large profits, and then suddenly threatens to collapse because the supply of cash has been exhausted. Credit is not readily available for most new corporations. The or- ganizers turn hopefully to the natural recourse of selling more stock, and usually find themselves confronted by a blind wall of skepticism. It is a curious fact that an entirely new project, which exists only as an idea and has not yet been troubled by any of the harsh vicissitudes of business existence, appeals strongly to the imagination and is generally able to command capital with comparative ease ; whereas exactly the same project six months or a year later, when substantial progress has been made and its profitableness has been in part demonstrated, is no longer appealing and raises new capital with difficulty. The reason is no doubt to be found in the fact that the owner of the 770 CORPORATE FINANCE [Bk. II- capital in the second case looks at the project at close range, sees it in its prosaic realization and can hardly conceive it as a great money maker. In the first place his imagination was left untrammeled. Promoters are insistent, therefore, on one piece of advice in which they all agree : in organizing a new enterprise, raise at the outset all the capital required to bring it to success. One difficulty that often comes up at this point is that of estimating the amount of cash capital required. The strong tendency is to underestimate. Even where a new proposition is of quite a definite character, that is to say, where it involves buying a given property or properties at an agreed price, turning out a stable product for an assured market and selling it at a price known in advance even under such conditions underestimates are frequent. They most commonly arise from two oversights : first, the neglect to provide sufficient working capital; 2 second, overlooking the incorporation and selling expenses to start the corporation and dispose of its capital stock. Selling expense of capital stock may run as high as 25% or 30%, or even more. 207. Effect of Inadequate Funds The following is a typical experience in organizing a small corporation with insufficient financial backing : About two years ago I was induced to purchase stock in the Johnson Manufacturing Company, which owned the patents and intended to manufacture and sell an office equipment device. Only one other person was interested and he took an equal amount of stock and was to be the active man at $150 per month. It was nearly six months before we were able to get our dies constructed and sufficient stock on hand to go after business, and this work took a lot more money than we anticipated. We also had trouble with our finish and replaced a lot of our devices which we had placed in the first few months. Manufacturing difficulties were finally over- come and we have had no other complaints on that score. Our difficulty now is to market the product. Sales for the year have been only about 2,500 units. See Chs. XV and XVI. "Working Capital Requirements." Ch. 20] PROMOTION METHODS OF FINANCING 771 Up to this time about $20,000 has gone into the business and as yet we are hardly making expenses on average monthly sales of $1,000. It has come to the point now where we must find a more profitable method of merchandising, sell out, or liquidate. We would prefer to sell out, but we have nothing very encouraging to offer a purchaser, so it resolves itself into one of the other two. A first-class merchandising man, in whom both of us feel confidence, could be secured if we were in position to put in another $10,000 so as to make sure that the business runs for another year. Personally. I am convinced that with the right plan of sale, the whole project would be a tremendous money maker, but we haven't the cash our- selves, don't know where to turn for it, and haven't much of a record to fall back upon. 208. Causes of Failure The stories of loss in establishing enterprises that are known to be in themselves sound and profitable, are so numerous that probably every reader can pick one or more out of his own experience or observation. It will take very little analysis of each one of these cases to demonstrate that the loss has been due to carelessness in one or more of the following features : 1. In not ascertaining all the available facts in advance of investment. 2. In neglecting to clinch the legal rights of the organizer by means of contracts, options, or the outright pur- chase of some of the essential property. 3. In failing to establish close relations with financial houses which would be of assistance in carrying the enter- prise through the construction stage and up to the point where securities could be sold as the issues of an estab- lished concern. 4. In making insufficient estimates of capital require- ments, including not only fixed capital but also working capital and the necessary expenses of selling securities. All these errors with a little judgment and foresight are easily avoidable. CHAPTER XXI 209. Professional Promoters The word "promoter" has come to be associated with Colonel Sellers and J. Rufus Wallingford, and consequently is commonly regarded as a term of reproach rather than of praise. Yet when it is used in its proper sense, it indicates a man of exceptional energy and foresight who is able to conceive a new enterprise and to set it on its feet. He belongs to the class of men who make for progress. One unfavorable connotation for the word comes out of the expression, "professional promoter."' Each one of the two words in the expression is innocent in itself, but where they are combined they seem to imply an individual who is making his money by his wits either at the expense of the enterprise he is supposed to finance, or of the dupes whose money goes into these enterprises. There is undoubtedly some truth in this implication, for a certain group of semi-criminals who call them- selves brokers and promoters make it their business to prey upon struggling enterprises and defraud them while they pretend to assist. Yet there are some men of excellent standing to whom the term "professional promoter," if used in its correct sense, could properly be applied. Of this type are such men as Charles M. Warner, who took part in promotions so widely separated as the American Malting Company, the Corn Products Refining Company, the Bay State Cotton Corporation, the International Cotton Mills Corporation, and the National Asphalt Company. To the same class belong many of the most prominent financiers of the day, who have assisted with more or less directness in all 772 Ch. 21] THE PROMOTER 773 the great promotions and combinations of the past twenty years. The professional promoter is not, however, of so much importance to the business world as what may be termed the occasional promoters who make up in the number of enterprises promoted for the smaller average capitalization of each. These promoters come mainly from the following classes: Local lawyers and bankers Engineering firms Business executives 210. Local Lawyers and Bankers There is little to be said, if we are to speak in general terms, of the activities of local lawyers and bankers as promoters. It is enough to call attention to the fact that ordinarily they are natural leaders in organizing new local enterprises. If some western country town is establishing a new creamery or a new cannery; if in some eastern city there is opportunity for a com- bination of small local manufacturing concerns; if a man of in- ventive talent gets up a new device and begins to talk among his friends as to the possibilities of developing it in any one of these cases the opportunity usually comes straight to the lawyer or banker who is in position to give it some of his time and and thought and perhaps to carry it through to success. The number of such cases of local promotions on a small scale is sur- prising and accounts for a considerable proportion of the annual crop of new enterprises, 211. Engineering Firms as Promoters It is well known that a few large engineering firms of high standing have organized and financed and now manage thousands of street railway and other public utility corporations, especially in the smaller cities and towns. Among the most important of these firms may be mentioned Stone and Webster, J. G. White Engineering Corporation, H. M. Byllesby and Company, and 774 CORPORATE FINANCE [Bk. II- Henry L. Doherty and Company. All of these firms, it is stated, have more or less drifted into their present promotion activities. The business of each firm was primarily to carry on professional engineering work. As they grew in size and the expense of maintaining a large staff of high-priced experts became a greater and greater burden, it was found necessary to go beyond merely seeking profitable work for these men and to embark upon the policy of creating work for them. This could be done only by actively organizing and financing new corporations with which the firm then made contracts for engineering service. Promotion at the beginning, then, was a side issue; but it has grown and grown until one, at least, of these firms is regarded as much more distinctly a financial house than an engineering firm. We might include with this group some of the large manu- facturing companies which are actively engaged in financing new enterprises with a view to obtaining their orders for ma- chinery and other equipment. Among the concerns that have followed this policy with the greatest enterprise and success are the Westinghouse Electric and Manufacturing Company, and the General Electric Company, which through subsidiary cor- porations disposed of the securities of a great number of enter- prises which they desired developed. All such concerns, after their ability to sell securities once becomes known, are deluged with a constant stream of applica- tions for assistance in developing new enterprises. Any of these which appear to be worth while are investigated along the lines suggested in the preceding chapter. In case the investigation yields a favorable report and it is decided to take hold of the new enterprise, they proceed to capitalize and incorporate it in accordance with the principles previously discussed. The pro- cedure thereafter differs. 4Some of the firms work in close con- nection with banking houses which underwrite the securities of their corporations and proceed to sell them to the general public. Other firms have their own departments or subsidiary corporations for the sale of securities, thus carrying through the Ch. 21] THE PROMOTER 775 whole enterprise from its inception through the investigation, the flotation, the construction of the plant or property, and even beyond this, through the initial stages of its management. 212. Business Executives as Promoters In forming combinations among competing manufacturing plants, it is not at all unusual to find the initiative taken by the manufacturers themselves. Sometimes they get together and, through a committee or through informal discussion, agree upon some plan of combination which shall take in all the previously competing plants. This was done in the case of the leather, cordage, asphalt, and glucose combinations. In a case of this kind it is hardly correct to speak of a "promoter." There is really not much need for his services, inasmuch as the manufac- turers manage the matter themselves. Another situation exists in some industries where there is keen competition and possibly some ill-feeling, but where one plant or one individual stands out as a recognized leader, either through size, enterprise, personality, or other cause. If a com- bination is to be formed in an industry where this situation prevails, it may be easily possible for the leading firm or in- dividual to become the promoter. This was true in the case of the salt, malting, and bicycle combinations. It constitutes a somewhat exceptional case when a business executive or a group of executives in one concern actually promote a combination with their rivals. The case is exceptional for the reason that no man readily subordinates himself to a former competitor or is easily reconciled to entering a combination in which his com- petitor, starting from the same level as himself, takes a leading part, including a large block of promoter's profits. It is far easier for a man from the outside to cany through such a com- bination. The customary case of the business executive acting as a promoter arises in the formation of entirely new enterprises. The man who takes the lead in such an undertaking is commonly 776 CORPORATE FINANCE [Bk. li- the same man who expects to manage it after it is organized. In many respects this is the correct arrangement. When the promoter forms a combination and then ceases his active con- nection with it, he is usually influenced wholly by his desire to sell stock and float the new enterprise, and not at all by con- sideration of the future requirements of the enterprise. When the future manager of the enterprise himself promotes it, this situation does not exist. There is though, on the other hand, the corresponding danger that if he is not skilled in such matters the promotion manager will underestimate the financial needs of his enterprise, or perhaps while securing his capital if he is successful in getting it will reduce it below the amount really required by unnecessarily crude and wasteful promotion methods. In the interests of men of this type, a few remarks as to points they should watch in forming their financial plan will not be out of place. 213. Promotion Requirements First of all, it is necessary that sufficient capital should be raised or 'authorized ; yet, on the other hand, it is desirable, if the period of construction and development is to be lengthy, that the sale of securities should be postponed until the cor- poration is actually on its feet. There may seem to be at first glance no possibility of reconciling these two conflicting re- quirements. The solution of this problem is to be found in such connections with banking houses that they will be willing to carry through the preliminary financing and underwrite the sale of the securities of the completed proposition. This is one of the devices universally used in large enterprises, but seldom in small ones. There is no reason, however, why it is not almost equally well adapted to the small concern, which through the local bankers should be able to secure accommodation on the strength of its own securities as collateral and may later sell those securities and repay the bank loan. A second point to notice is that the promoter must protect Ch. 21] THE PROMOTER 777 his own interests, for he may be sure that no one else will do this for him. If he is acting as a principal, the proper method of taking care of himself is to raise all the capital that is needed, on as good terms as possible, by the sale of bonds, preferred shares, and common shares, retaining for himself the remaining equity in the business. This is the place where many business executives, as promoters, fail to realize the full returns to which they are entitled. They are likely to put in their own money under precisely the same conditions as the money of other people, without reserving for themselves the equitable interest which belongs to the promoter of the enterprise and which any other promoter would easily obtain. 214. Protecting the Promoter When the promoter is not acting as a principal, or is as- sociated with others in the promotion or is perhaps acting for others, and especially if he merely plays the part of a "connecting link," his interests must be protected by definite contract. A case in which, according to his own story, the promoter failed to give himself proper protection, came into the New Jersey courts some years ago. It appears that Harry C. Haskins claims to have been the originator of the scheme to unite all the inde- pendent lead companies not previously included in the National Lead Company. He went to Thomas F. Ryan, the well-known financier, and enlisted his support. Mr. Haskins charges that after Mr. Ryan and his friends had secured from him all the information they needed, and had made use of his knowledge of the lead business, resulting from years of study, they froze him out of the deal, and that while Mr. Ryan made enormous profits as the promoter of the consolidation, he himself had received nothing. Without attempting to express any opinion whatever on the merits of this case, it is plain that in the eyes of the law Mr. Haskins could have little standing. He had no property right in the idea of forming the consolidation; the facts and 7?8 CORPORATE FINANCE [Bk. II- figures which he submitted to Mr. Ryan were apparently freely given. He may have had a verbal understanding, but, if so, it can be best described as an agreement to make an agreement, fulfilment of which cannot of course be compelled in equity pro- ceedings. In other words, the original promoter, Mr. Haskins, according to his own statement, did not contractually protect himself. He went ahead before he had "assembled" his proposi- tion. 215. Promotion Difficulties Under the most favorable circumstances the promoter does not lead an easy life. In investigating whatever proposition he has in mind, he must expend both money and time freely and it is quite likely that his efforts will be fruitless; he must exercise diplomacy and patience in securing his options or other- wise assembling his proposition; he must protect himself with the greatest care and forethought if he is to reap the reward of his efforts; he must approach the owners of capital with a proposition which he believes to be favorable to them, and yet must be prepared for rebuffs and suspicion. These are the cus- tomary difficulties in promoting an enterprise. The above difficulties are doubled or tripled when the enter- prise is a combination of previously independent concerns. And if the combination includes concerns that have been pre- viously competitive, the promoter is, first of all, confronted with the necessity of conciliating individuals who perhaps for years have been fighting each other with all the weapons at their command. Furthermore, the business interests of each separate concern going into the combination demand that it should make for itself the largest claims that it can reasonably support and should look with much suspicion on the claims that are advanced by the other concerns. Unless the promoter is a man of much force and unusual tact, it is almost inevitable that the negotia- tions should break off as a result of mutual distrust. This has been the result again and again, even though every person Ch. 21] THE PROMOTER 779 interested may have fully recognized the proposed combination as desirable for the common good of all. 216. Difficulty of Creating a New Organization In addition to the questions and conflicts that arise in de- termining the financial terms, the creation of a working organi- zation for the combination is more than likely in itself to break up all negotiations. If the promoter is a true diplomat, he will usually try to postpone consideration of management personnel until after the combination as a whole has been pretty well decided upon. Nevertheless, it may at the last moment wreck the whole project. The promoter must usually make up his mind between one of two courses: either he must bring in an outsider of high standing as the chief officer of the combination and give him discretion to pick the best men he can find, thus creating an efficient working organization; or he must "play politics" and choose the officers from the men whose influence he requires in order to . form the combination. If he chooses the first alternative, he must make his appeal most strongly to the men who have capital invested and whose business sense will lead them to respect the necessity and justice of the proposed course of attion, even though it may involve sacrifices on the part of some individuals. If he chooses the second alternative, he must make his appeal primarily to the active officers of the concerns that are to be combined, and must depend upon them to help him in influencing the owners of capital. Unfortunately this second alternative is too often chosen, and is probably the direct cause of the breakdown of various combinations which should have proved highly successful. 217. The Chances of Success The probabilities are that loss and failure in promotion is the ultimate result of fully one-half of the serious attempts to start new enterprises. There are, to be sure, classes of enterprise in which failure has become rare, as for example public utility 780 CORPORATE FINANCE [Bk. II- corporations. The standards for estimating the probable income and expenses of such corporations have become so exact, and the estimating is now so carefully and scientifically done, that there is little reason to fear disaster. Other enterprises, particularly those engaged in manufac- turing industries or trading, are apt to be shipwrecked through lack of careful calculation, foresight, and provision for the future. Yet in addition to these probable causes of disaster, there are innumerable contingencies which cannot be foreseen. This is true of all business enterprises. In addition to the seri- ous risk that the new enterprise itself may prove to be unsuc- cessful and all the promoter's profits, as far as represented in common stock, may be wiped out, there is the further risk to the promoter that he may fail to carry through the enterprise and may lose all his own expenditures of money, time, and energy devoted to its promotion. 218. Promotion Profits Some indication has already been given of the customary method by which the promoter takes his profits. As a funda- mental principle he is entitled to whatever remains of the capital- ized value of the enterprise after it has been financed,. To make the practice entirely clear, let us take a simple hypothetical case. A promoter determines that a given manufacturing enterprise will reasonably earn, after it has completed a two- year period of development, in excess of $110,000 per annum net profits. If he is conservative, he will perhaps figure on creating securities all of which should be salable at par on the following basis: Interest Capitalization and Dividend Requirements $ 500,000 7% first mortgage bonds $ 35,000 250,000 9% preferred stock 22,500 500,000 common stock yielding 10% 50,000 $1,250,000 $107.500 Ch. 21] THE PROMOTER 781 We will assume that the corporation actually needs $1,000,- ooo cash, and that the expense of investigating, securing options, incorporating, and selling securities amounts in total to $150,000. Under these conditions, the promoter would probably enter into a contract to turn over $1,000,000 in cash, or possibly property and total assets for which he would actually pay $1,000,000, in exchange for all the bonds, preferred stock, and common stock of the corporation. He would then be able to sell bonds, preferred stock, and $250,000 of the common stock, and would retain for himself $250,000, against which should be offset his expenses of $150,000. In other words, under all these estimates his net profits would be $100,000, which would be realized in common stock. The principle that the promoter should have as his com- pensation a portion of the final equity in the corporation, is well established in what may be termed the more conservative promoting circles. Otherwise in case, for instance, he insists upon receiving bonds or preferred stock he reveals a lack of faith in the success of the enterprise that would probably be fatal to his whole promotion scheme. This principle of common stock for the promoter obtains quite generally in the United States. In English practice another arrangement, which is in some respects preferable, has been common. In addition to bonds, preference shares, and ordinary shares, the organizers of a new corporation frequently created another claim on the property, ranking after ordinary or common shares, which is represented by what are known as "founders' " shares. The founders' shares ordinarily are entitled to dividends only after certain dividends have been paid on ordinary shares, after which they are entitled to a special participation in additional divi- dends. 1 A favorite arrangement of this kind is to give the ordinary shares, say, 6% as their preference above founders' shares, >See HS4. 55- 782 CORPORATE FINANCE [Bk. II- and then to divide any additional dividends equally between ordinary shares and founders' shares. The founders' shares are usually issued to a small nominal amount with a small par value to each share, often only one shilling. In a few instances where the companies have been phenomenally successful, the founders' shares have become extremely valuable, and there are even cases in which separate corporations have been formed in order to hold the total block of founders' shares and to sell interests in this block. The advantage of this English practice is that it defers promoters' profits until after those who have contributed cash have been fully protected. 219. Illustrative Instances A few instances from corporate practice will show just how promoters have secured their profits. 2 In the case of the Mount Vernon-Woodberry Cotton Duck Company, the promoters had remaining in their hands $6,- 250,000 in common stock. Figuring its market value at $25, this amounted to a cash profit of well over $1,500,000. How- ever, Mr. Parks, the chief promoter, was in no situation to keep all these profits for himself; they were divided to a great extent among the various mill owners whose personal co-operation had been necessary. The United States Realty and Construction Company was incorporated in 1902 with a capitalization of $30,000,000 pre- ferred and $36,000,000 common stock. The five promoters, among whom were some of the best known and most highly respected citizens of New York, stated publicly that they would receive a profit for organizing the new corporation and for pro- curing the necessary working capital. The announcement was put in the following form: It is proper to state that we expect to receive for the responsi- bility and risks assumed by us in organizing the new corporation, * From Dewing on Corp. Prom. & Reorg. Ch. 21] THE PROMOTER 783 procuring the cash capital, and for the expenses incurred, an in- dividual profit which will or may include the stock of the new cor- poration remaining in our hands after carrying through the trans- action. The promoters' profits in this case are calculated to have amounted to about $6,000,000 in common stock, or approxi- mately 10% of the total securities. At the outset the market value was about $1,800,000, and it had an average value dur- ing the first year of $720,000. From the above instances it is clear that successful promotion may carry with it very large profits. There are at times exces- sive profits, and yet on the other hand there are very heavy expenses and very great risks which seem, on the whole, to make promotion profits in the majority of cases reasonable. CHAPTER XXII PROMOTERS' PROFITS 1 220. The Work of the Promoter A promoter, as considered here, is one who actively engages in the financing and organization of an enterprise under the corporate form. The term is described by an English authority as a "short and convenient way for designating those who set in action the machinery by which the Act enables them to create a corporation." Cook briefly classifies the promoter as a "person who brings about the incorporation and organization of a corporation." 2 Another idea enters into the modern every-day business use of the term. The promoter's activity and interest in the affairs of the enterprise are incited by the expectation of special profits. If he does not realize or expect to realize special profits out of the undertaking, he is not, in modern parlance, a promoter, though filling every requirement of the legal definition. In the organization of most modern corporations the promoter plays an active and very important part. His anticipated special profits from these efforts are usually large and not infrequently excessive. As stated in the preceding chapter, among the more conservative promotions these profits are taken in the stock of the new undertaking. This, however, is far from being an invariable rule. On the contrary, the ordinary promoter is usually very anxious to secure his profits at the earliest possible moment and in some more realizable form than stock in his too often doubtful enterprise. To accomplish this the more easily and to secure larger profits than would otherwise be 1 Adapted by permission from Corp. Org. & Mgt., by T. Conyngton. * 3 Cook on Corp., ( 651. 784 Ch. 22] PROMOTERS' PROFITS 785 possible, he sometimes attempts to make his profit a secret profit. The many different arrangements whereby the promoter en- deavors to secure his special profits in the form and in the way he prefers, have given rise to a class of cases turning solely upon the relations existing between the promoter, his associates, and the corporation. The ideal of the law in regard to these relations is high. It is to be regretted that the ideals and methods of promoters are usually on a much lower level. 221. Promoter's Relation to Corporation In a large proportion if not the majority of cases, the pro- moter brings about the organization of his corporation for the express purpose of securing special profits. There is no intrinsic iniquity or injustice in so doing. The only question is as to the propriety and legality of his arrangements for collecting these profits. Too frequently the methods of the promoter are not only of doubtful moral status, but directly in conflict with the established law. The relation of the promoter both to the corporation and to those associated with him in its organization is one of trust. He is guiding the affairs of the incipient corporation and is supposed to be safeguarding its interests as he would his own. This doctrine is too clearly established to be questioned. The confidential relations of the promoter being admitted, it follows, then, that while he may with ontire propriety profit by his connection with the corporation, such profit must be of such a nature as is compatible with confidential relations. 222. Illegal Arrangements Corporations can be formed through irresponsible agents with ease. If these agents can vote away a substantial part of the capital stock for property of comparatively small value, and still with immunity to themselves and their principals receive from the uninformed public, cash subscriptions for the rest of the capital 786 CORPORATE FINANCE [Bk. II- stock, the organization and management of corporations might readily become a "system of frauds." 3 The usual mistake the promoter makes is in dealing with his corporation as he would with a stranger. Unreasonable or even large profits are difficult of attainment if the party from whom they are to be drawn is informed as to the facts, and for this reason, as stated, the promoter wishing to sell property to the corporation he has organized, or caused to be organized, fre- quently conceals or, worse still, misrepresents the real cost. When the promoter occupies this position, he is in conflict with the law, for it has been laid down clearly and unmistakably that a promoter must not make any secret profit out of his corporation, or out of those associated with himself in the formation of the corporation. 223. A Case in Point The leading case on this subject is an English case, 4 but its doctrines have been generally followed in this country. One Erlanger and his associates formed a syndicate to purchase an island containing phosphate which was offered to them for 55,000. Through agents a company was then formed, Erlanger naming the five directors. Of these, two were at the time out of the country. Of the three remaining, one was Erlanger's private agent, one was Lord Mayor of London, and the third was a Rear Admiral of the British Navy. These two latter were not interested in any way with Erlanger in the sale of the island to the corporation, were not informed as to the circum- stances and did not make any inquiry, but, acting with the Erlanger director, accepted Erlanger's proposition to sell the island to the corporation for 80,000 in cash and 30,000 in shares. Stock in the corporation was then sold until some 400 shareholders were interested in the company. Later these secured control of the company, and, having discovered the * Old Dom. Copper Co. v. Bigelow, 203 Mass. 159, 188 (1909). 'Erlanger v. New Sombrero Phosphate Co., 5 Ch. Div. 73; affd., 3 App. Cases 1218. Ch. 22] PROMOTERS' PROFITS 787 facts as to the sale of the island, promptly brought suit against all parties concerned in its sale to the company. As a result, the sale was ordered rescinded and the vendors were ordered to return the price of the island to the company, upon which the island was to be restored to its original owners. This decision was affirmed upon appeal. The Lord Chancellor, in rendering the decision, said: I do not say that the owner of property might not promote and form a joint-stock company, and then sell his property to it, but I do say that if he does he is bound to take care that he sells it to the company through the medium of a board of directors who can and do exercise an independent and intelligent judgment on the trans- action, and who are not left under the belief that the property belongs, not to the promoter, but to some other person. The doctrine of the case was, first, that independent directors should have been named; and second, that the promoters should have made full disclosure to these directors of all material facts. In the decision it was intimated that if one director personally beyond suspicion had known and approved the real facts as to the increased price, it might have been sufficient to validate the sale. The doctrine in this country is similar. When property is taken by promoters for the purpose of sale to the corporation, whether by purchase, option, or agreement, they are bound to disclose any private bargain or secret profits. The relations are confidential and each person is bound, as in partnership, to act with entire openness and fairness to those with whom he is associated. The law as to this is very clear and has been passed upon again and again. To sum the matter up, any special profits made by the promoter are illegal unless made with the full knowledge of all the others interested, or with the consent of an independent and fully, informed board of directors, or with disclosure of the conditions to those who are asked to subscribe to the stock. If special profits are made otherwise, suit for redress may be 788 CORPORATE FINANCE [Bk. II brought at any subsequent time by the corporation, or, under some circumstances, by the stockholders who have contributed to the promoter's improper profits by the purchase of stock on its first issue, or of treasury stock thereafter. 224. Improper Profits vs. Overvaluations These cases where suit is brought for the restoration of promoters' profits must not be confused with that other class in which recovery is had by creditors because of the overvaluation of property turned into the corporation in exchange for stock, or bonds, or both. The two cases often go together, but are radically different in their nature. An improper profit to pro- moters might exist without any overvaluation, and an over- valuation might exist without any improper profits to the promoters. For instance, property at an overvaluation might be accepted by the corporation and its stockholders with a full knowledge of the promoters' profits. They would then have no basis for proceedings against the promoters. A creditor might, however, in such case proceed against the stockholders on the ground of an overvaluation. On the other hand, the property might be put into the corporation at a fair figure, but the promoters receive a secret commission, or rebate or other improper profit on the sale. In such case there would be good grounds for proceeding against the promoters for the recovery of the improperly gotten profits. In the various states the decisions in regard to promoters' profits vary in their tenor, but there is a general trend toward a stricter construction of the promoter's duty and responsibility to his corporation. 5 225. Legitimate Profits The laws are very clear in their denunciation of the pro- moter's secret profits. They are hardly less explicit in their 'Old Dom. Copper Co. v. Bigelow, 188 Mass. 315 (1905); s. c., 203 Mass. 159 (1909); See v. Heppenheimer, 69 N. J. Eq. 36 (1905); Arnold v. Searing, 78 N. J. Eq. 146 (1910). Ch. 22] PROMOTERS' PROFITS 789 recognition of the promoter's right to profits if secured and taken under proper conditions. ''There is no rule of law prohibit- ing a person from forming a corporation for the purpose of selling property to it and making a profit from the sale. The law merely requires that such a transaction be entirely open and free from deception upon the company and those who become members."" In a New Jersey case the court said: 7 Buck, as the promoter of the corporation, stood in a fiduciary relation to the company as soon as it was organized. As such promoter, it was open to him to sell property which he owned to the company, on making full and fair disclosure of his interest and position with respect -to that property. Not only was such dis- closure necessary, but it was incumbent on him, as sole promoter of the company formed to purchase this specific property, controlling and moulding its organization, to furnish it with an executive or board of directors capable of forming competent and impartial judgment as to the wisdom of the purchase and the price to be paid. 226. Rule as to Property Owned by Promoter Also, if the promoter purchased or otherwise acquired the property in question before the inception of the corporation and before he assumed in any way to act for it, he was not, and could not be held as, the agent or trustee of the corporation when he purchased the property. He may therefore have acquired it at any price or in any way, and when later the corporation is organized, he is at liberty to offer his property to the corporation at any advanced, or different price he may choose, without divulging the profits to be made thereby. The one essential in such cases is that the promoter's interest in the property shall be disclosed, and that such offering shall be absolutely without misrepresentation. If he represents that the property is owned by him when held only by option, or that it is turned in to the corporation at the cost to him when he is really making T Morawetz on Priv. Corp., { 293. Plaquemines Trop. Fruit Co. v. Buck. 52 N. J. Eq. 210, 230 (1893). 7QC CORPORATE FINANCE [Bk. II- a profit, such misrepresentations are, under the circumstances, material and render the promoter liable for the secret profits, so secured. Without, such misrepresentation, however, he may make what profit he will. In a case that came up in the New York courts, property was turned in at a gross overvaluation, but the only persons in interest were informed of all details and did not object; therefore the promoters were held to be within their rights and the con- tract not subject to rescission. 8 Also in a Maryland case, 9 a receiver attempted to hold the promoters responsible under the same circumstances, but his application was denied on the ground that there was no conceal- ment and therefore no wrong. From this it would appear that, if with the full knowledge of all concerned as to the circumstances thereof, a corporation is organized and property is exchanged for a portion or the whole of its stock, the completed transaction has harmed no one, is absolutely legal, and is not open to later objection by any of the parties consenting thereto. The promoters may make such profits as they please, provided the other participating parties consent thereto, and up to this point the transaction is legitimate and unobjectionable. Nor is there danger of any subsequent objection, no matter what profit may have been made by the promoters, if the price paid for the property taken was within reason, or capable of justification. Nor is there any danger of adverse legal action even if the price and profits were entirely out of reason and totally unjustifiable, provided creditors and subsequent stock- holders are informed as to the conditions before they give credit to the corporation or invest in its securities. > Parsons v. Hayes, 14 Abb. N. C. (N. Y.) 419 (1883). Tompkins v. Sperry, Jones & Co., 96 Md. 560 (1903), CHAPTER XXIII SOURCES OF CAPITAL FUNDS 227. Capital from Stock Subscriptions The typical corporation starts in much the same way as the typical partnership through an agreement on the part of two or more men who are acquainted with each other, to join forces in a business enterprise. In a partnership, these men sign a formal partnership agreement and pool part or all of their capital and other resources; in a corporation, they mutually agree upon the amount of capital required, the amount of capital stock to be authorized, and the issuance of the stock for cash, property, and services. No matter which financial form is adopted, the essential fact common to both is that the money and the business ability required are supplied by the same men. As the corporation expands (assuming that it is a success) and fresh capital is needed, it may come in whole or in part from the same group of men. In case their capital has been exhausted or is otherwise tied -up, the next move, frequently, is to find some other man who has capital to invest and who at the same time will be a valuable addition to the executive staff of the business. Some concerns keep on growing in this way for a long time. Other concerns by far the vast majority soon attain their normal volume of business and thereafter need little if any fresh capital. In both these cases, the source of capital plainly is the man or group of men who are themselves active in the management of the business. 228. Capital from Operating Profits A second source of capital, which usually operates in con- nection with the source just named, consists of savings out of 791 792 CORPORATE FINANCE [Bk. li- the profits of the business. Practically every concern saves and adds to its permanent capital a portion of its profits. In corporations which are owned by the people active in the busi- ness, the tendency is strong toward putting a large proportion of the profits back into the business. The active men realize the needs and the possibilities in the business better than outside stockholders could possibly do. Sometimes they are willing to put back practically all the profits and to keep up this policy over a period of years. The enormous capital of the Carnegie Steel Company was, for example, almost wholly built up by this method. Much the same thing is true of the Winchester Repeat- ing Arms Company before its absorption by the Winchester Company, and of many other closely held and highly successful concerns. Until the time of the Great War with its insistent demands for new capital, the Bethlehem Steel Corporation was a conspicuous example of the results which may be achieved by the patient saving and reinvesting of profits over a series of years. At the present time the United States Steel Corporation has a surplus of over $500,0x20,000 built up from earnings. 229. Outside Sources of Capital Funds Most companies that are successful on a large scale reach the point, in the course of a few years, where more capital is needed than can possibly be supplied by the people who are directly engaged in handling the business. Some corporations, as we shall see, reach this stage at the very beginning; that is to say, they start full blown as publicly owned enterprises. They are, however, exceptional. Whenever it is necessary to go outside the group of men who are directly connected or directly familiar with the enterprise, the capital may be said to be raised from the public at large. For our purpose we may divide this public, as is customarily done in nearly all writing or thinking on financial subjects, into two fairly distinct groups: those who invest and those who speculate. The investing public consists of the people who are more Ch. 23] SOURCES OF CAPITAL FUNDS 793 concerned over the safety of their principal than they are over large returns. The speculative public consists of those who are desirous of large returns and to secure these are willing to accept more or less risk on their principal. Distinct types of security issues are designed to appeal to these two groups. There is, of course, no sharp dividing line between the two types. 230. The Investing Public The word "public" suggests a large crowd of individuals, and the term "investing public" may easily call up a vivid picture of thousands of staid and prosperous persons, buying bonds, putting them away in their strong boxes, and periodically cutting off the coupons. This picture is to a certain degree true when we come to the purchasers of those investments which have a slightly speculative tinge, such as bonds that sell on a basis of 6% or more. John Moody, however, is authority for the statement that the really "gilt-edge" investment securities are taken chiefly, not by individuals, but by institutions. These securities sell on the basis of, say, 4^% to 5K%> and the indi- vidual investor is much more apt to be a contributor in some way to the support of these large investing institutions, rather than a direct purchaser of this type of securities, i^vj 231. Investing Institutions First among the institutional investors, we find banks. Savings banks are enormous purchasers of the highest grade bonds. Under the laws of most states their purchases are closely restricted to bonds of a certain approved class which are frequently referred to in Wall Street as "savings bank bonds." Commercial banks, also, from time to time take large quantities of investment securities, chiefly short-term obligations. Insurance companies spend a vast amount an- nually in the purchase of investment securities. All institu- tions the funds of which are held in trust, such as universities, philanthropic institutions, and the like, must confine themselves 794 CORPORATE FINANCE [Bk. II- strictly to investment securities. Estates of deceased persons, administered in trust, are large purchasers. Institutions, then, constitute the public to which the highest grade investment securities must be sold. Individuals handling their own funds are free to exercise their discretion and take whatever degree of risk there may be in the purchase of securities that do not comply with the strict terms of the laws covering institutional investment. It will be readily seen that there are noteworthy advantages to the corporation which can adapt any important part of its securities to the requirements of institutional investment. First of all, such securities are in high demand and sell at excellent prices. Second, they are likely to "stay put" after they are sold. The institution ordinarily does not die or become hard up or panic-striken; consequently, securities which it has once pur- chased are likely to remain with it until they mature. Through- out the crisis in the affairs of the New Haven Railroad Company in 1913-1914, the debentures of the company, which were closely held by insurance companies and savings banks, did not to any great extent come on the market. 232. Investment Associations In other countries, even those individual investors who in this country would buy securities direct are apt to efface them- selves as individuals and join investment trusts or investment associations. These associations are common in Great Britain, France, and Holland, and are not uncommon in other countries. The investment associations frequently sell their own bonds as well as their own shares. They take the money thus obtained and invest it in securities of other corporations. What is the advantage, it may be asked, of this indirect method of investing? The great advantage is that the uninformed judgment of the individual who purchases only a few stray securities from time to time, is replaced by the trained and experienced judg- ment of men well acquainted with investment securities and Ch. 23] SOURCES OF CAPITAL FUNDS 795 the investment market. This at least is the theory of the situation. There is another advantage, also, in the fact that, instead of having available for investment only the small savings of individuals, the investment association deals in large sums and is therefore in a position to buy advantageously. Further- more, on account of its large purchases it can distribute its risk over a wide field. Its securities, for instance, would not all be bought in one country but in several countries; they would not all be in one or two lines of business, but in many lines, and so on. This principle of the distribution of risk is the most practical form of insuring the safety of the investment that has yet been brought forth. The investment associations, as a rule, are managed with skill and ability, and in the long run make money, though there . are of course some unfortunate exceptions. 233. Speculative Public The purchasers of speculative or even semi-investment securities are, with negligible exceptions, individuals. The term "semi-investment" in this connection is applied to such securities as high-grade preferred stocks and junior bonds, which are customarily regarded as reasonably safe but which are not savings banks' investments, and are subject to a greater degree of fluctuation and uncertainty than the strictly high-grade investments. There is a fairly clear threefold division of the immense number of purchasers and possible purchasers of specu- lative and semi-investment securities: 1. The buyers who have in view primarily the safety of their principal, in which they do not anticipate any great appreciation in value, but who desire a larger rate of return than can be obtained from strictly investment securities. These are the purchasers of junior bonds, preferred shares, and the like. 2. The purchasers who are looking primarily for an increase \n the value of their principal, though they do not object, naturally, to a high percentage of yield. These are the pur- 796 CORPORATE FINANCE [Bk. II- chasers of common shares, especially those which are not so thoroughly seasoned as to approach the semi-investment grade of securities. The members of this group are likely to be for the most part people who have some especial connection with, or interest in, the corporation, the shares of which they are pur- chasing; often they are minor officers or employees of the cor- poration. 3. The speculators on margin, who operate on the Wall Street and other stock exchanges. A large number of them are merely gambling; others have some special information as to a given corporation the shares of which are listed on the stock exchange, and are trying to make capital out of their information. Still others are observers of general market conditions, and buy and sell standard issues with little regard to their intrinsic value, but with a great deal of regard for the buying and selling movements on the exchange, 234. The Scope of the Market A remarkable feature of the last ten or fifteen years in the United States has been the widening distribution of the shares of large corporations, indicating that a greater and greater number of people who possess or can save capital are putting their money into corporate securities. Taken in the aggregate, the size of the speculative public in the United States is enormous. This is well illustrated by the number of stockholders in the five great corporations given below, these five having among them over 640,000 stockholders. No. of Stockholders United States Steel Corporation 189,060 Pennsylvania Railroad Co 141,699 American Telephone & Telegraph Co 185,000 General Motors Corporation 70.504 Cities Service Co 62,322 648,585 Ch. 23] SOURCES OF CAPITAL FUNDS 797 The United States Steel Corporation has, as shown, over 189,000 shareholders of record, among whom are included many foreign investment associations and other holders who are practically trustees for a considerable number of people, so that the total number of persons financially interested in United States Steel shares is probably well over 200,000. In 1901 the average holding of United States Steel shares was $32,000; in 1906, $15,000; in 1913, $7,000; in the early part of 1922 it was estimated at less than $5,000. This, while there is a steady and rapid increase in the number of stockholders, shows a material decrease in the average amount of stock held by each. It is clear from all these facts, that the most successful and most popular corporations are carefully cultivating the good- will of the owners of small amounts of capital, including their own employees, and that a notable transfer of ownership into the hands of a larger number of people is in process. This does not, for the present, necessarily mean a transfer of control, which is usually safely in the hands of a few large holders of shares. Yet it involves some tendency at least toward corporate democracy, both in the ownership and in the control of large corporations. 235. Small-Scale Selling From this same source the speculative public must come the capital for small enterprises. After an enterprise has passed the stage in which the capital is furnished by those directly engaged in the enterprise, if the business itself is worthy and sufficiently profitable, there is no good reason why it should ever fail from lack of sufficient capital. The failure in most instances where needed capital is not obtained is due to a misconception of method. When one of the enormous, nationally known corporations, with years or perhaps generations of success behind it, desires to obtain fresh capital perhaps from $5,000,000 to $25,000,000 its officers enter into a contract with some banking firm which 798 CORPORATE FINANCE [Bk. II- undertakes to furnish the capital and which in turn disposes of the securities of the corporation among its own clientele. This is the big-scale method of raising fresh capital from the speculative public. The actual work of selling the corporate stock is not performed by the corporation's officers. All that they do is to make the right kind of contract. Often the manager of a small local corporation forms the idea that he should and can raise his capital in the same im- personal way, or that he must go far from home to get the money he needs. He altogether forgets that his neighbor Jones has just sold a farm and has $10,000 lying idle in the bank; that his customer Smith is a good personal friend of his and can raise any reasonable amount of money; that his employee Brown is building up a good-sized savings account and would save more and work better if he were stimulated by the pride of owning an interest in his employer's business. Instead of interviewing Jones, Smith, and Brown, with money in their pockets which they would willingly exchange for shares in his enterprise, the corporate manager of this type is apt to think that some broker in a distant city could easily raise the $10,000 or $50,000 that is needed if he could only be persuaded to undertake the job. The best place to begin looking for purchasers of specu- lative or semi-investment securities of a small corporation is among business acquaintances of the men who are already interested in the corporation. After a few of these acquaint- ances have themselves become shareholders, they will co-operate in reaching other people, and so the list of prospective pur- chasers of the securities will expand in an ever-widening circle until the whole amount of the capital required has been raised. Often the best person to whom to turn for advice is the most progressive banker in the community or if it is a large city the banker best acquainted with the trade in which the cor- poration is engaged. It is the banker's business to know the standing of his customers and advise as to their investments. CHAPTER XXIV SELLING SECURITIES DIRECT TO BUSINESS ASSOCIATES 236. Four Methods of Sale When a corporation is organized, and in many cases from time to time during its life, some of its securities must be sold. The initial capital must of course be raised by the sale of securities; subsequent capital may come either by savings out of profits or by fresh sales of securities. We shall take up, in the order named, the four methods of sale commonly used: 1. Allotment to insiders or to previous shareholders. 2. Direct sale to the outside public. 3. Sale to banking houses, which in turn dispose of the securities by direct sale to the outside public. 4. Sale to banking houses or brokerage houses, which in turn dispose of the securities through the machinery of stock exchanges. The term "insiders," as used above, includes all who are either active in, or closely connected with, the management of the corporation. The term is not used in any derogatory sense, but merely as a convenient designation for those who have intimate relations, so to speak, with the concern. In very small or closely held corporations assuming that there is good feeling among the various persons interested it is customary to allot securities as they are issued, to all those actively interested under some kind of mutual agreement. The universal rule of law is that where new voting shares are issued by an established corporation, every voting shareholder must have an opportunity to take up the new shares in proportion to his holdings of the 799 8oo CORPORATE FINANCE [Bk. II- old shares. Unless there is some agreement to the contrary, it is generally found advisable in close corporations to allot new issues of common stock on this basis. Preferred stock and bonds are more likely to be sold to outsiders. 237. Cultivating the Stockholders' Good-Will Corporations already established and going ahead success- fully which require fresh capital from time to time for expansion of their activities, find it highly profitable to cultivate the active good-will of the stockholders. This applies especially to companies having many stockholders, most of whom are not in close touch with the management of the business. The man who has invested money in the stock of a corporation is likely to feel a certain personal interest in its continued success and growth; he usually likes to be considered, not as a complete outsider, but as a person who is entitled to special information and privileges. He therefore follows its fortunes with more than usual interest and is peculiarly approachable, if he is kept in an interested frame of mind, when a proposition to make a further investment is brought before him. In the language of salesmanship, two steps making a favorable approach and arousing interest have already been taken. The corporation presumably possesses his confidence. The succeeding steps creating a desire to invest further and securing his decision to do so should be comparatively easy if he is in a position to make further investments in anything. The idea of deliberately setting to work to cultivate the friend- ship of the body of shareholders not identified with the manage- ment, may be regarded as a recent development in business finance. Even yet, there are comparatively few corporations which have grasped and consistently apply the idea. The ten- dency still persists among the corporate officials to regard the average stockholder usually unknown personally as merely a name which some clerk enters upon the books. We may go a step farther and say that in many corporate offices he appears to Ch. 24] SELLING SECURITIES DIRECT 801 be regarded as an unavoidable nuisance who insists on draining away with his dividend checks if he is fortunate enough to get them the earnings which the officers and directors would much prefer to retain for themselves. The truth is that the average stockholder is a human being who likes to be treated as such and who will readily \respond if he is treated with fairness, courtesy, and some degree of cordiality. 238. Methods of Cultivating the Good-Will of Stockholders There are many ways in which the interest and good-will of the stockholders can be cultivated. On one occasion when the stockholders of a great railroad received their dividend checks, they were at least mildly surprised and to some extent interested to find enclosed an attractive account of a trip to the Yellowstone National Park, which the railway company was promoting, together with a return post card on which the stockholder might inquire for further details. The National Biscuit Company some years ago sent out to their stockholders a "Pandora Box" which contained samples of many of the company's products. The Loose-Wiles Biscuit Company followed their example. Swift and Company not only furnish their stockholders with a formal annual report, but with an attractively illustrated "Year Book" which contains an intimate review of the internal workings of the company. As stated in the preface of the 1920 edition, "Originally this annual publication was intended for the information of shareholders; the demand from the general public has increased to such an extent, however, that it has been enlarged from year to year and is now distributed in large numbers to all who wish to send for it." Among the many subjects discussed in the 1921 edition, are: Earnings, Dividends and Surplus, Number of Shareholders, Sales, Beef Prices, Proposed Legislature, Wages, Relations with Employees, Prospects, and "Shareholders Should Use Our Pro- ducts," under which title it is said, "If every one of the 40,000 8o2 CORPORATE FINANCE [Bk. II- shareholders should become familiar with our products and insist upon buying them, it would have a valuable effect on the busi- ness." Armour and Company also get out a handsome annual publication, illustrated in colors, for the information and interest of their shareholders. Of a somewhat different order and severely plain in appear- ance, but issued for the same general purpose, is the annual report of the American Telegraph and Telephone Company. The following quotation is from the 1921 report: To THE STOCKHOLDERS: It is the purpose of these reports to make clear to a large and steadily increasing body of stockholders not only the present financial status of their properties, but also such facts as to the broad and far-reaching extent of the Company's business, the in- sistent and steadily increasing demand for additional telephones and facilities, as will enable them to form accurate judgments as to the soundness of the structure which has been successfully created, and the assurance of continuing returns on their investments. In addition to the annual report, many of the larger corpor- ations publish periodicals or issue special reports from time to time which are sent to their stockholders, and which not only keep these latter informed as to what the corporation is doing, but are an efficient aid in cultivating their good-will and in increasing their friendly interest in the corporation whose shares they hold. Corporations which work along such lines- may safely count on finding their shareholders responsive when a new issue of securities is offered to them. 239. Cultivating the Good- Will of Employees In discussing this subject of relations with shareholders, it is convenient although it might logically come a little later to treat the subject of relations with employees. The modern corporation with broad-gauged management is no longer in- clined to treat its employees as if they were outsiders entitled to no special consideration. On the contrary, a direct conscious effort is continually being made to bring them into sympathy Ch. 24] SELLING SECURITIES DIRECT 803 with the point of view of the management and, whenever possible, to persuade them to participate actively as share- holders in the risks and profits of the business. An effective appeal to employees is that of Swift and Com- pany. The following statement is from the 1920 report: 1919 EMPLOYEES' STOCK SAVINGS PLAN In order to encourage saving, thrift, and loyalty on the part of employees, a new plan was put into effect on June 2, 1919, permit- ting employees to purchase some of Swift and Company's treasury stock at par ($100 per share) when the market value was about $136.00 per share. Employees earning less than $20.00 a week were allowed to pur- chase one share, the number of shares increasing with the weekly salary so that those earning $50.00 and over could purchase five shares. Payment is on the instalment plan, $1.00 a share a week to be deducted from employee's wages until paid in full. The results a year later are given in the 1921 report: Swift and Company now has over 40,000 shareholders of record, over 13,000 of whom are employees. There are only four or five other corporations in the United States whose shares are more widely held. In addition to our shareholders of record, there are more than 7,000 other employees who have subscribed for shares under our 1919 Employees' Stock Savings Plan, making a total of over 20,000 of our 60,000 employees who are, or will soon become, shareholders of record. The results from the Employees' Stock Savings Plan upon which we reported at the last annual meeting have been very encouraging, and we have thought it wise to keep this plan in operation. In 1921 the United States Steel Corporation sold 255,325 shares of stock to 81,722 employees. 240. Cultivating the Good- Will of Customers In a field which is entirely unrelated, the same plan was adopted by one of the great public utility corporations of the United States the Pacific Gas and Electric Company. The 804 CORPORATE FINANCE [Bk. II- report of this company for the year ended December 31, 1914, states that a campaign to induce its customers to become further interested in the operation of the company by pur- chasing first preferred stock had been successful, $4,000,000 of this stock having been taken up by customers and over $500,000 additional by employees. In the first six months of 1915, an additional $1,800,000 of the stock was sold to 1,069 customers. It is clear that one result of this policy must be to secure a higher degree of local public interest and to strengthen the bonds which unite the corporation in friendly relations with the communities which it serves. The same idea is available for almost any kind of enterprise. The Hammond Typewriter Corporation of New York, in the early part of 1922, sent out the following appeal to its customers: The BOARD OF DIRECTORS of the HAMMOND TYPEWRITER CORPORATION extends to MR. JAMES WILSON an invitation to inquire concerning his privilege of becoming a member of its Founders Underwriting Syndicate and participating in the $437,0x30 of underwriting stock profits to be divided among syndicate members. The enclosed card of inquiry, mailed promptly will bring you full particulars. Very truly yours, G. J. EDMONSON, Vice-President In explanation of the above appeal, the company says: "In order to provide the additional working capital for this business expansion, the Hammond Typewriter Corporation is inaugurating, through its Founders' Underwriting Syndicate, a plan of stock distribution which marks a new era in industrial financing." Ch. 24] SELLING SECURITIES DIRECT 805 The same idea has recently been used with success in securing additional capital for a moving picture company, which appealed to the patrons in attendance at its theaters; similarly the W. L. Douglas Shoe Company advertised an issue of preferred stock in connection with the advertisements of its shoes and presumably with success, as its outstanding preferred stock increased from $2,500,000 on July 5, 1919, to over $3,700,000 in December, 1920 the period during which the advertising appeared. In all probability the same policy of appealing to customers and prospective customers could be applied advantageously in thousands of other enterprises. Many an owner of a small business who chafes helplessly against his "lack of capital" and blames the "trust" for his poor success, could obtain all the capital he needs if he would work out a sound proposition and present it by letter or in person to the people who are already interested as his customers. 241. The "Stock Right" When a corporation desires to obtain capital by issuing additional stock, it extends to its stockholders the privilege of subscribing to the new stock, in proportion to their individual holdings, at a price fixed below the market value of the outstand- ing stock. This privilege of subscribing, technically known as a "stock right," is evidenced by a formal document or "warrant," which in appearance resembles a securities certificate. r ,- n< Stockholders are permitted to assign or transfer this subscrip- tion privilege to others in case they do not care to take advantage of it themselves. Such transfers are made in the open market and as the new stock is offered at less than the market price of the old stock, the rights possess value. 242. Two Definitions of the Stock Right In offering new stock to its shareholders, the corporation announces that those of record on a particular date will be 1 The discussion of "rights" which follows is written by Thomas York, author of "Foreign Exchange." 806 CORPORATE FINANCE [Bk. II- entitled to subscribe to the new stock on the basis, say, of one new share for every two shares of the old stock owned by them on the specified day. In different localities usage varies as to what a single "stock right" is. According to one usage, the term refers to the privi- lege of subscribing for one new share. Thus, if the holder of two old shares is entitled to purchase one new share at the specified price, he is considered to have one right, a holder of 100 old shares to have 50 rights, etc. Each stockholder, in other words, has as many rights as the number of new shares he may subscribe for under the company's offer. In its other usage the term "stock right" means the sub- scription privilege attaching to each share of the old stock. In the example cited the holder of two old shares has two rights as thus defined, the owner of 100 shares has 100 rights, etc. When this meaning is assigned to the term, a stockholder has as many rights as he has shares of the old stock. This is the signification ordinarily attached to the term stock rights in New York, and as it is proposed here to describe rights as they are bought and sold in the New York market, the term will be used in this latter sense only. 243. Conditions of Subscription Offer To take a hypothetical example, suppose the Manufacturing Corporation of America with a capital stock of $1,000,000 divided into 10,000 common shares, each of $100 par value, all outstand- ing and with a market value well above par, decides to offer to its stockholders 5,000 shares of additional stock at par. The first official announcement of this sale of new stock is made to the company's stockholders and reads in substance as follows: The Manufacturing Corporation of America will extend to its shareholders of record on May i, 1922, the privilege of subscribing, at $100 a share, to 5,000 shares of additional common stock, of $100 par value, in the ratio of one share of new stock for every two shares of old stock held. Subscriptions will be payable on or before Ch. 24] SELLING SECURITIES DIRECT 807 June i, 1922. Transferable warrants specifying the number of new shares for which they are entitled to subscribe will be mailed to stockholders of record as soon after May i as practicable. New York, April 2, 1922 244. Trading in the Rights The three dates in the foregoing announcement define the period in which the stock rights may be sold and the two distinct stages of trading into which this period is divided. Trading in the rights commences April 2, immediately upon the public announcement of the new issue. The prospective rights, however, go with the shares until May i, and therefore the market value of the shares up to that date includes the value of the rights; or as it is commonly expressed, the stock sells "rights on." 245. Sales of Rights on a "When Issued" Basis All rights traded in between April 2 and May i are bought and sold on a "when issued" basis. That is to say, a stockholder who does not wish to sell his stock but does wish to sell his rights before May i, may make such sale for delivery and pay- ment a few days after May i, when the warrant will be avail- able. The sale is made at the prevailing market price, and the first problem is how that price is determined. If upon the company's announcement of the new subscription on April 2, Jones purchases in the market two shares of the old stock at $150 a share, he will, on May i, receive the two rights that will entitle him to subscribe for one new share. This he does, and on June i he is the owner of three shares in the com- pany's increased stock, which have cost him a total of $400, or an average of $133^ per share. Suppose that instead of exercising the two rights and sub- scribing for one share of new stock, Jones sold the rights on April 2, each for the amount of the difference between $150 (the prevailing market price of the old stock) and $133^ (the aver- age cost per share of the old and new stock combined) that is, 8o8 CORPORATE FINANCE [Bk. II- for $16%. The cost of each of his two shares would be in that case reduced by this amount to $i33H> as * s evident from the following: Cost of two shares of old stock at $150 per share $300 Amount realized on the sale of the two rights Net cost of the two shares $266% Net cost of one share $133^ From the foregoing it is plain that a purchaser of the old stock at $150 fares the same on the sale of the rights at $16% as he does when he retains the rights and subscribes for the new stock at $100, as in either case the cost is $133^ a share. 246. Parity Value of Rights Dealt in "When Issued" In this situation, with the rights quoted at $16^ and the stock at $150, there is neither gain nor loss in dealing in the rights, for it then matters not whether one purchases two shares of the stock and subscribes for a share of the new stock against the two rights which accompany the two shares; or whether he purchases six rights and acquires three shares by subscription. In either case the cost per share is $133^. In this price relationship the rights are said to be at parity with the stock and their value is referred to as the parity value. The rule for ascertaining the parity value of a right when the market quotation for the stock is given, is easily deduced from our example. It will be observed that the difference between the market price of $150 for the old stock and the subscription price for the new is equal to three times the parity value of $16% for the right. Hence the parity value is equal to this difference of $50 divided by 3, which divisor, it will be noticed, is equal to the sum of the terms of the ratio of subscription, i and 2. It will be found that this rule is of general application where the sub- scription ratio is given in terms of the number of old shares entitled to subscribe to one new share. Hence, if m represents the market price of the old stock, s the subscription price of the Ch 24] SELLING SECURITIES DIRECT 809 new, and n the number of old shares carrying the subscription privilege to one new share, then p, the parity value of the right, . m s equals n + i 247. Tendency of Rights to Parity Value As for the actual market price of the rights, this shows a constant tendency to equal the parity value, and therefore also fluctuates with the market value of the stock ; for whenever any appreciable difference arises between the parity value and the market price* of the rights, it becomes profitable to undertake certain market operations in the rights and the stock, the effect of which is to render the market price of the rights equal to their parity value. These operations are of three kinds, as follows: i. PURCHASE OF RIGHTS. Suppose that the price of the old stock is $150, so that the parity value of the rights is $16%, and the market price of the rights is $15 In such case rights are relatively cheaper than the stock, and those who wish to acquire stock in the company will do better to purchase rights and sub- scribe for new shares than to buy old shares, as is shown below : (a) When old stock is purchased : Cost of purchasing two shares of old stock at $150 $300 Subscription price of one new share (the two rights being acquired with the purchase of the old stock) 100 Cost of the three shares $400 Cost of one share $133^ (b) When rights are purchased: Cost of six rights at $15 per right $ 90 Subscription price of three new shares 300 Cost of the three shares $390 Cost of one share $130 Thus the saving by purchasing rights is $3^ per share. 2. SALE OF STOCK AND PURCHASE OF RIGHTS. If the market price for rights is less than parity, a profit accrues to owners of the old stock who sell and at the same time buy the 8lO CORPORATE FINANCE [Bk. II- number of rights necessary to secure a like amount of new stock. Thus: Sale of two old shares (with rights) at $150 yields $300 Value of the two rights attaching to the two shares sold 30 Amount realized for the stock exclusive of the rights $270 Purchase price of four rights at $15 per right $ 60 Subscription price of two new shares 200 { o/() kpo ol '(Dfi Total cost of the new shares 260 Profit on the two shares $ 10 Profit on one share *. . $ 5 The proper basis for comparing the amount realized on the old stock with the cost of purchasing rights and subscribing to the new stock, is to compare the old and the new stock as they will be after May i when the old stock loses the value of the rights. This is done in the computation by deducting the market value of the rights from the proceeds of the sale of the old shares. 3. ARBITRAGING TRANSACTIONS. The disparity between the market price for the stock and that for the rights gives oppor- tunity also for profitable operations by brokers who make more or less a specialty of this class of business. These transactions are called "arbitraging transactions," and consist of: (a) Selling the stock "short" (i.e., the broker does not have the stock but borrows it to make delivery) . (b) Buying rights and subscribing to the new stock. (c) Turning this stock over to the lender of the old stock. The following example indicates the method of computing the arbitrageur's profit: He sells two old shares "short" at $150 $300 At the same time he purchases six rights at $15 per right . $ 90 He subscribes for two new shares 200 Total cost of the two new shares 290 His total profit on the turnover of two shares $ 10 His profit on one share ; $ 5 Ch. 24] SELLING SECURITIES DIRECT 8ll It will be noticed that the arbitraging broker purchases two ' rights more than the four required for subscription to two shares of new stock. These two extra shares he delivers to the lender of the two old shares after the stock sells ex-rights and the warrants are issued. That is, he borrowed two shares which carried with them the rights, and he now returns their equiva- lent in the shape of two rights and two shares of the new stock, the latter of which he delivers when the certificate is available after June i. The effect of the foregoing three classes of operations, occa- sioned as they are by the presence of a disparity between the market quotations for the stock and the rights, is to cause a readjustment in the demand and the supply of the stock and the rights. The demand for the rights is increased, while the offer- ings of the stock are augmented. As a consequence of this, the market price of the rights rises above $15, and the market price of the stock falls below $150; and with that the two quota- tions are drawn toward mutual parity. If this tendency hap- pens to be strong enough to overcome any forces operating in the opposite direction, parity between the quotations is eventu- ally realized, as when the stock is quoted at $148 and the right at $16 ($148 minus $100, divided by 3, equals $16). 248. Rights Quoted at a Discount and a Premium Almost invariably any disparity between the stock and the rights is a discount from the parity value of the rights at the moment. The reason for this is that when the privilege of sub- scribing to additional stock is extended to shareholders, many of them sell instead of exercising their rights. Pressure is thus exerted on the market for the rights and causes their price to fall below parity. This in turn, through the operations of those who take advantage of the disparity to effect a saving or reap a profit, reacts on the price of the stock and may cause it to fall also, though not necessarily, as parity may be brought about simply by the market price of the rights rising. 812 CORPORATE FINANCE [Bk. II- Instances of the opposite disparity, in which the market price of the rights is at a premium above the parity value, are extremely rare. Perhaps the most notable case, in recent years, of this sort of disparity was in the sale of rights to a new issue of Texas Company stock in 1915. At one time the stockholders stood to save as much as $6.50 a share by buying the old stock and selling their rights to the new stock. 249. Stock Selling Ex-Rights When the company closes its stock ledger on May i, it takes the list of stockholders and prepares warrants to evidence the pro rata subscription privilege of each. The outstanding shares no longer carry a right to the subscription of l /t share of the new stock, and thereafter are sold "ex-rights," that is, minus the rights. Dissociated from the stock, the rights become the sub- ject of independent trading, free and apart from the stock, in the manner of ordinary securities. On the New York Stock Exchange, stock begins to be quoted ex-rights at the commencement of trading on the day the sub- scription privilege takes effect, May i in our example. This is because of the Stock Exchange's system of settlement, which calls for the payment and delivery of the stock on the day fol- lowing the transaction. On May i, when the stock ceases to carry the right, its market quotation loses the value of the right. Accordingly, when the market opens on that day, the price of the stock is marked down from .the closing quotation of the previous day by the amount of that value. Suppose, for example, that the last quotation for the stock on April 30 was $150, and for the right $16. Other things being equal, the stock will begin the next day at $134. But as other things are generally not equal, instead of starting at $134, the stock is very likely to begin above or below that figure. In expressing the price change from the last quotation of the preceding day, account is only taken of this deviation from $134, because the amount deducted for the value of the Ch. 24] SELLING SECURITIES DIRECT 813 right has not been lost through any depreciation but is now simply represented by what is virtually a separate security. 250. Parity Value of Rights When Stock Is Quoted Ex-Rights It has been noticed that in the first period of trading in the rights, when the stock sells "rights on," the difference between the market price of the shares and the subscription price of the new stock is, in our example, three times the parity value of the right. Since the price of the stock is reduced on May i by the value of one right, it is evident that in the second period of the trading, from May i to June i, when the stock sells ex-rights, the difference between the stock quotation and the subscription price is only twice the parity value of the right. Thus the parity value of the right is now found by taking the difference between the market quotation for the old stock and the sub- scription price, and dividing this difference by the number of rights necessary to subscribe to one share of new stock. Hence the formula for finding the parity value of the right when the m s stock is selling ex-rights, is . n The market price of the rights during this second period tends to coincide with this parity value, because any wide divergence from the parity value at once opens an opportunity for arbi- traging and other transactions entered into for a profit, which bring the stock and the rights closer to parity, just as when the stock is selling "rights on." uii l?.o CHAPTER XXV jiti tii ami.ijnj jo fioa-xj .;ri* Ivjoi- SELLING SECURITIES DIRECT TO OUTSIDERS -jd) )o *>Lf!.: / --/Jhfiq- $&P&tm 39irtJ ,i>IqrriX3 TUG ni t ai jbata wan 251. The Problem We may next take up the case of a corporation which desires to raise a considerable amount of new capital either at its organi- zation or at some later stage in its development, and which can- not count on meeting its needs by selling to its own stockholders or to those intimately associated with the business as employees or customers. The corporation, we will assume for the present, either cannot command or does not desire to obtain the services of bankers or stock exchange brokers, but wishes to deal directly with the prospective purchasers of its securities. In other words, the corporation is in the position of wishing to sell its own securi- ties to the public at large without the employment of inter- mediaries. In such case the corporation must look for prospective buy- ers and must carry on an active campaign for the purpose of disposing of its securities. To determine the amount and nature of the securities to be offered belongs to the field of financing proper; what methods should be adopted in disposing of these securities directly to investors is primarily a selling problem. This problem as applied to the sale of securities may be analyzed as follows: 1. How shall the names of prospective buyers be obtained? 2. What is the most suitable and attractive manner of ap- proaching these prospective buyers? 3. How shall their interest be aroused? 4. How shall their confidence be secured? 814 Ch. 25] SELLING SECURITIES DIRECT 815 5. How shaft a desire be created on their part to purchase the securities that are being sold? 6. How shall a favorable decision and consummation of the sale be secured? It is necessary here only to present a few remarks as to the application of the principles of salesmanship to this problem of disposing of securities. 252. Selling by Mail Order Methods The first method of reaching prospective buyers which occurs to many organizers or managers of small corporations, is ad- vertising or extensive circularizing. This method, however, has proved itself almost worthless for sound, legitimate enterprises, although it is extensively used by unsound enterprises. First of all, the very fact that swindling promoters endeavoring to float the securities of worthless oil companies, mining companies, and the like, have used this method so largely is almost a decisive argument against it. It has become perhaps unfortunately so closely associated with fraud that any offer of stocks through widespread advertising and circularizing is at once looked upon with suspicion by conservative men. A more fundamental ob- jection is that the method is bound to be expensive. It is not likely that any securities, unless they should be the securities of companies already widely and favorably known, could be sold by advertising and circularizing at an expense of less than 25% to 50% of their offered price, which is entirely too high for a legitimate enterprise. Generally speaking, the selling expense of legitimate securities ought not to exceed 5% to 10%. While this is true, it is also true that the government of the United States employed mail order methods in selling Liberty bonds, and in connection with other methods, employed it with signal success. It is also true that oil companies, reputable and fairly prosperous, can be found in Texas and elsewhere, whose securities have been sold through mail order and general adver- 8l6 CORPORATE FINANCE [Bk. II- tising work. It is also true that the method may be and has at times been employed economically and with success by cor- porations in other lines and in other places. Nevertheless the general condemnation of the method is sound. It may also be said that this condemnation of mail order methods of selling securities does not, of course, extend to the advertising of high-grade securities by reputable and conserva- tive banking houses. Such advertising is customary, dignified, and usually effective. 253. Circularizing Special Lists The usual mail order method of selling securities may be modified by limiting it to selected lists made up, for instance, of the customers or probable customers of the enterprise. If the list is carefully selected, and the circularizing carried on in a dignified and effective manner, this method may sometimes prove inexpensive and successful. The suggestion in the preceding chapter as to the possibilities of securing capital from customers and employees supports this view. It must be borne in mind, however, that there is grave danger here of arousing the suspicion that the corporation is financially embarrassed, or at any rate is not sufficiently well financed to provide funds in the usual ways for its proper development. 254. Personal Selling The third and ordinarily the best method of finding prospec- tive buyers for securities of small corporations is through per- sonal effort. It may seem at first glance that this statement is in contradiction to the customary practice in marketing commodi- ties. "Experience has long ago proved," it may be argued, "that personal salesmanship is a slow and highly expensive method of selling automobiles, real estate, and many other high-priced commodities. At any rate, it should be supplemented and sup- ported by advertising, circularizing, and other cheaper methods. Why should not the same principle apply to the sale of securities?" Ch. 25] SELLING SECURITIES DIRECT 817 The answer to this natural inquiry is that the element of con- fidence in the management of an enterprise and in the salesman is a vastly more important factor in effecting the sale of stocks and bonds than it is in effecting the sale of such things as auto- mobiles and real estate. The purchaser of a security does not regard the transaction as terminated when he pays over his money and receives his certificate or his bond. On the contrary, he is just beginning at this point his relations with the corpora- tion and its management. If he is wary, therefore and the majority of people with capital to invest are wary he will not part with his capital until he feels well assured of the honesty and competence of the management of the enterprise. When the corporation is well established and well known, or when the offer comes to the prospective purchaser through a banking house of high standing, or even through a salesman whom he knows and believes in, or when he is personally acquainted with the man- agers, the necessary feeling of confidence is quickly established. If none of these favoring conditions exist, however, the best sub- stitute is for the salesman to approach the prospective buyer with a personal introduction or recommendation which tends to establish confidence. Here we have the basic reason for the unquestionable fact that only through the personal influence and activities of the re- sponsible officers or of trusted representatives can the securities of a small corporation be successfully sold to the general public. For this reason the expense of finding prospective purchasers through such impersonal methods as advertising or circularizing is in almost every case prohibitive. The organizer or manager of a small corporation which needs capital may as well make up his mind at once that he is the man who should find the capital, and that he should work through his acquaintances and through the respected business men of his community or of his line of business. He may be greatly sur- prised to find how quickly and easily he can locate capital, the existence of which he had not previously suspected. 818 CORPORATE FINANCE [Bk. II- 255. The Prospectus For the same reason that the seller of most commodities needs either a sample or a catalogue, the seller of securities needs a prospectus. This in its essential characteristic is a written state- ment of the history, the present condition, and the prospects of the corporation and of the terms on which its securities are offered for sale. No prospective purchaser of securities, who is not one of the inside managers of the concern, will be likely to buy until after a written statement has been put into his hands and he has had an opportunity to look it over. Even though his analysis of the statement may not be thorough, still the fact that it is made in writing tends to increase his confidence. Verbal assurances which he discounts acquire greater strength when they are committed to permanent written form. The written state- ment may take the shape of a private letter; it may be a some- what more formal typewritten statement; or if intended for wider distribution, it may be printed. The form in which the statement is given does not change its essential character: it contains the definite representations on the strength of which the security is being sold, and for this reason is of importance both in effecting the sale and in connection with any legal questions that may later arise. -T< Mfi; t 'i-Mj'ini : 256. Statements of the Prospectus If the corporation which is selling the securities is well estab- lished and has been running for some years, the most important statements in the prospectus are the records of earnings and the balance sheets. These statements should be scrutinized and analyzed with the greatest care. Attention should be given to omissions as well as to allegations of fact. The record of earn- ings, for example, should go back, not one or two years, but pos- sibly five or six years. The list of assets in the balance sheet should be checked with a suspicious eye, and it should be noted whether ample reserves for depreciation and loss have been es- tablished. Sometimes it is claimed that it would be inadvisable Ch. 25] SELLING SECURITIES DIRECT 819 for a prospectus to present records of earnings over a period of years, on the ground that this would be making public informa- tion that might be of value to competitors. If the business is of so secret a character that even its records of profits are not to be made known to its stockholders or prospective stockholders, it is certainly not the kind of a business which should offer securities to the public at large. A common practice in writing prospectuses, and one which properly arouses suspicion, is the presentation of vague and plausible statements that do not commit the corporation or its promoter to anything definite, and yet are intended to create the impression that remarkable profits are in prospect. In the pros- pectus of a small copper mining company, for example, it is stated that "copper mining has proved a source of some of the greatest fortunes the world has ever known, and its possibilities are not yet exhausted." This statement is literally true, and in its proper context is certainly not objectionable. But when it appears in a prospectus, with the obvious intention of suggesting that the particular company which is offering its stock is likely to prove a boundless source of wealth, it may well cause suspicion as to the entire sincerity and good faith of the authors of the prospectus. Because of the fact that glowing statements beget suspicion rather than confidence, the writers of prospectuses for high-grade companies frequently go to the other extreme and decline to commit themselves in any way as to the future. They will not even express an opinion. By so doing they may avoid straining anyone's confidence in their statements, but they lose the persuasive power of their own well-founded belief in the future growth of the enterprise. The skilled prospectus writer will steer his way carefully between these extremes, 257. Names in the Prospectus An important factor in creating confidence, especially in a new corporation, is the list of names of men who are identified with the management or have consented to join the board of 820 CORPORATE FINANCE [Bk. II- directors. It is entirely proper that these names should appear in the prospectus, and if they are the names of men known for their probity, business ability, and general standing, nothing better can be brought in. Knowing tnis to be true, however, un- scrupulous promoters of doubtful undertakings frequently and deliberately set to work to secure "ornamental" directors who, for some consideration or because of personal vanity, are willing to become members of the new board. The practice is a vicious one and the careful purchaser of securities is likely to be repelled rather than attracted when he sees a number of widely advertised names of this kind included in the directorate. 258. Style of the Prospectus It is always desirable that the prospectus should be dignified in its form and in its contents. Red ink and buffoonery may con- ceivably help to sell some commodities, but they will not help to sell thousands of dollars of stock and bonds. A man who is thinking of putting his money into securities, generally looks upon the proposition seriously and does not ask to be either startled or amused. However, this need not prevent a strong appeal at times to other motives besides money-making. A trust company in a small Texas city, for example, which had been unable to raise additional capital that it badly needed, found that it had no difficulty in getting capital as soon as it put its appeal on the ground of the local pride which should be felt by the leading ranchers and merchants of the community in building up a sound financial institution. The sentimental appeal, if it is used, must of course be sincere and legitimate. Otherwise it becomes mere bathos and a destroyer of confidence. 259. Limitations on Direct Sale of Securities One advantage of selling securities direct, rather than through bankers and brokers, is the belief commonly held by the pur- chasers that in this way they avoid paying the expenses of the tn. 25] SELLING SECURITIES DIRECT 821 sale. They argue to themselves that if a brokerage firm were to dispose of a block of securities, it would require a commission of, sav > 5% to 10% or more, whereas when the corporation itself, through its officers or direct representatives, disposes of its securities, no commission need be paid. It is of course obvious that there is very apt to be a fallacy here, inasmuch as the effort and expense on the part of the corporation in conducting the sale is just as truly selling cost as would be a commission paid to bankers or brokers. As a matter of fact, the moment direct sell- ing of its own securities by a corporation goes beyond a certain limited field, it usually becomes impracticable on account of its high cost. As already stated, advertising and circularizing ordi- narily will not produce the right kind of inquiries for legitimate propositions except at excessive cost. Personal work on the part of officers or promoters of a corporation, who inquire among their friends and proceed from one man to another until they reach people with money to invest, is also likely to be slow and expen- sive. The idea is not impracticable indeed at times is very ad- vantageous when the amount of capital to be raised is compara- tively small but as the amount of capital increases, the diffi- culty and expense of this method become progressively greater. 260. Effect on Public of Direct Sale of Securities Another factor when direct selling of large issues of securities by a corporation is under consideration is the effect on the public. Such a sale is not considered "good form." As stated by a lead- ing financial writer: Investment securities of standing are sold through investment bankers; those of little or doubtful value may be sold direct by the issuing corporation or distributed by irresponsible promoters or fiscal agents, with the help of extravagant advertising matter. . In this respect there is a very strong prejudice to deter a corpora- tion engaged in the railroad, lighting or manufacturing business from trying to sell its own securities. So strong is this feeling that investors assume that the corporation cannot find a reputable banker to offer its securities if it resorts to offering them itself. . . . 822 CORPORATE FINANCE [Bk. II- It is true that in spite of all reasons why corporations should not market their own securities there are many instances in which they have tried to do it. If the corporation enjoys strong credit, if the securities are conspicuously attractive, and if general investment conditions are very favorable, the sale will succeed. This does not prove, however, that such a policy is wise. 1 This does not of course apply to the smaller corporations, and especially when their stock is sold, presumably among friends and acquaintances, by their officers. It is, though, impossible to say definitely how much capital can properly be raised in this man- ner. That will depend in part on the personal resources and ac- quaintanceships of the officers. When the Continental Rubber Company later absorbed by the Intercontinental Rubber Com- pany was organized as a close corporation by a small group of wealthy New York capitalists, it had a capital stock of $10,000,- ooo, and all of this was readily sold by personal solicitation. On the other hand, an inventor who is not in touch with business men may find it a matter of great difficulty to raise a few hundred dollars. We can perhaps form some approximate idea of what the pos- sibilities are, by considering the fact that banking and brokerage houses rarely care to consider the sale of securities of corporations capitalized at less than $1,000,000; also that they do not care to undertake the sale of an issue of securities of less than $200,000. Blocks of securities of smaller amounts, therefore, cannot be sold ordinarily in any other manner than through the personal efforts of the promoters or managers of the corporation. Blocks of securities of larger amounts can generally, but not always, be sold more cheaply through banking and brokerage houses than through direct personal efforts. 1 Dewing on Finan. Policy of Corp., pp. 146, 148. CHAPTER XXVI SELLING SECURITIES THROUGH DEALERS; STOCK EXCHANGE METHODS 261. Classes of Security Dealers The general classes of security dealers correspond to the classes of dealers in merchandise, as follows: 1. Wholesalers 2. General retailers 3. Retail specialists It will quickly appear that these three classes are not clearly denned; nevertheless it is usually possible to classify a given banking or brokerage house as belonging to one of these groups. The wholesale dealers are interested only in the largest issues and make little effort to sell in small lots direct to individuals. In the United States, J. P. Morgan and Company, Kuhn, Loeb and Company, Speyer and Company, and a number of other firms not quite so well known, constitute this group. When a house of this type undertakes to sell a large issue, it usually proceeds to form an underwriting syndicate composed of firms which belong wholly or partly in the second group and which are equipped to sell the securities direct to the purchasing public. The second group includes such houses as Spencer Trask and Company, Harris, Forbes and Company, and the National City Company which might also be placed in the first group. These houses maintain large organizations of bond and security salesmen and keep comprehensive and valuable lists of people who are known to have money available for investment. Such houses, when they are members of underwriting syndicates, are prepared to assume a large share of the burden of actually 823 824 CORPORATE FINANCE [Bk. II- disposing of the securities offered. They may also take up smaller issues of securities wholly on their own account without forming an underwriting syndicate, and may dispose of these issues to the public. There is no sharp line between houses in this group and houses in the first group. The third group, consisting of specialists in the different classes of securities, is more clearly defined. It is distinguished from the second group by the fact that the list of prospective buyers in a specialty house is made up exclusively of people who have shown an interest in the specialty and is not merely a gen- eral list of people who have money to invest. The difference is much the same as between a department store and a retail shop which specializes in one line of goods. These specialty houses again differ from the stock exchange brokerage firms which are de- scribed a little later in this chapter. It would be impossible to list all of the specialty houses. One deals exclusively in oil stocks; another in the securities of the steel and iron companies; another in equipment bonds and car trusts; another in the first mortgage bonds of public utilities; another in bank, trust company, and insurance company securities. We may also include in this third group a large number of small banking and brokerage houses scattered over the country which specialize in local securities. Every city of any size has a considerable number of successful corporations the securities of which are from time to time bought and sold. These local firms handle business of this type. Usually they are also the corre- spondents and representatives of New York houses and are in position to help sell the big security issues in which New York is interested. 262. Handling an Issue A brokerage house in good standing which undertakes to sell a bond or a stock issue, will first of all wish to inform itself fully and accurately as to the soundness of the issue. It will carry on a preliminary investigation along the same lines that Ch. 26] SELLING SECURITIES THROUGH DEALERS 825 have been fully described in the chapters on promotion. In case the preliminary investigation is satisfactory and the terms are agreed upon, the house will then, probably through its own engineers and accountants, delve still deeper into the records of the corporation and satisfy itself beyond a doubt of the con- servatism of all statements upon which the sale of the security is to be based. Then it will proceed to dispose of the securities. Some general advertising of the security may be decided upon, and there is likely to be some circularizing with a dignified prospectus. Generally speaking, the real object of this adver- tising and circularizing is not so much to dispose of the issue immediately in hand, as to reinforce the work of its salesmen, and build up the firm's list of prospective buyers of securities. It is this list of prospective buyers which is the firm's chief asset. Having this list, it is not necessary that it should incur anew the expense of securing names of prospective buyers through advertising and circularizing each time an issue of se- curities is to be sold; that is, this expense is spread over the cost of selling many different issues instead of being chargeable wholly to one issue. fc-ia yrfj lo O .M> 263. Commission Payments It is clear that so far as investigation is concerned the ex- pense involved is almost as great for a small issue as for a large issue. Furthermore, the large issue is likely to be the issue of a better known corporation, can generally be sold in larger blocks than can the small issue, and as a rule is more easily sold. All three of these reasons operate to make the brokerage house anxious to secure the privilege of selling large issues at small commissions, and reluctant to undertake the disposal of small issues even at high commissions. When the joint loan of the English and French governments amounting to $500,000,000 was placed in this country in the fall of 1915, the bankers who handled it received a commission of When the National City Bank of New York in the pre- 826 CORPORATE FINANCE [Bk. II- ceding year undertook to sell $15,000,000 of the notes of the Argentine government in this country, the commission was 3,^2%. The large bond issues of great railroad corporations are ordinarily sold on a commission of 3% to 5%. The smaller bond issues and the first-class preferred stock issues of industrial concerns are sold at commissions of 5% to 10%, and the pre- ferred stock of the small industrial may have to pay as high as 20%. These higher commissions are not, however, usual, for the reason that the better established houses do not care to iden- tify themselves with any security which requires so high a com- mission. It is of course true that even higher commissions and special bonuses payable in stock of the issuing corporation are not unknown. When a brokerage house is handling a small issue and finds it difficult to make cash sales, it may resort to "swapping" for other better known securities that are owned by its clients. In this way the brokerage house may obtain bonds or stocks which it can actually sell for cash. The process, however, is more or less risky and expensive and amply justifies a high commission. 264. Obligation of the Brokerage House A question that is bound to arise whenever a bond or broker- age house recommends a security which afterward turns out to be a poor purchase, concerns the extent of the obligation which the house should be willing to assume. So far as the legal obli- gation goes, the house is always careful to protect itself by dis- claiming responsibility for the statements of fact which it trans- mits from the corporation to the purchaser. Thus the National City Company, in announcing an issue of $25,000,000 Gold Notes of the Consolidated Gas Company of New York, adds the following cautious note: "The information contained in this cir- cular is based upon official statements and statistics on which we have relied in purchasing these notes. We do not guarantee, but believe it to be correct." Also the selling house is careful that it shall always be clearly Ch. 26] SELLING SECURITIES THROUGH DEALERS 827 understood that any prophecies as to the future represent only its opinions and are not definite promises. This attitude is in itself entirely correct; yet there remains a certain moral obliga- tion which the better houses are quite willing to recognize. As to how far this obligation extends there is naturally considerable difference of opinion. Clearly there is a well-marked community of interest in this matter between a well-established banking house of high repute and its customers. The prosperity the very existence of the house is dependent upon its ability to retain the unquestioning confidence of a large number of investors. Every time a security which it handles goes wrong, that confidence is perceptibly dimin- ished. The reputable banking house, therefore, takes great pains in the first place to make certain that its statements of fact are fully verified and that its recommendations are justified. As a further protection, it is customary for the banking house to obtain for itself some kind of representation, direct or indirect, on the board of directors of the corporation. It is thus in posi- tion to keep itself informed and to exercise some influence on the future policies of the enterprise. If in spite of every precaution the corporation's record is unsatisfactory and the market value of its securities declines, the banking house will frequently try to maintain the market price. If the market decline seems to be due to extraneous factors rather than to any real falling off in the financial standing or profits of the corporation, the banking house will perhaps be satisfied with doing what it can to maintain the price and with reassuring its own clients. In case the situation becomes worse and the cor- poration finally goes through insolvency and reorganization, the banking house will do its best to secure favorable terms for the holders of the securities which it has itself recommended. It has even sometimes happened that the banker will repurchase securities which he has sold and which have afterward declined in value, at their original selling prices; but this is exceptional and is not to be expected as a regular policy. 828 CORPORATE FINANCE [Bk. II- On the whole, as the investing public comes to be better educated in financial affairs, and as the standards of correct practice in these matters become better established, there is a strong tendency toward more complete and unquestioning recognition on the part of the security merchant of his moral obligation. It is but rarely that the purchaser of securities from a reputable house has any cause for serious complaint. 265. Limitations on Sale through Dealers It was pointed out in the preceding chapter that issues below $200,000 are too small to interest the security dealers, and must, therefore, ordinarily be sold direct by the corporation or its promoters. This establishes in a general way a lower limit of the security merchant's activities. On the qther hand, very large issues of bonds or shares which soon after their issue will enjoy an active market on an important stock exchange, are frequently best handled with the assistance of stock exchange operations. This does not mean, as will be explained a little further on in this chapter, that the large banking houses do not underwrite and dis- pose of these securities. It means only that they use a slightly different method. Speaking in general terms, it is usually true that issues of say $10,000,000 to $20,000,000 and over, are listed on the New York Stock Exchange at once if the issue can meet the Stock Exchange requirements, and the efforts of the houses which handle the issue are directed toward encouraging pur- chases through the exchange as well as toward making sales direct to their own customers. Another limitation on the direct sale of securities by dealers to their customers is found in its cost. Besides paying the bankers' commission for selling its securities, the issuing cor- poration must frequently pay heavy expenses for legal opinions as well as fees to accountants, intermediary brokers, and others, which run to a high figure. Inasmuch as arrangements of this kind are of a confidential nature, they are not often accessible and for this reason it is difficult to give exact figures. Ch. 26] SELLING SECURITIES THROUGH DEALERS 829 Following is a statement showing the expenses incurred by A. L. Barbour in 1896, in carrying through the sale in London of 400,000 6% debenture bonds of the Trinidad Lake Asphalt Company: Underwriting commission, 10% 40,000 Fee to City of London Contract Corporation, Limited, and to Henry Bell, Esq 15,600 Expenses of the City of London Contract Corporation, Limited 1,022 Fees to Seward, Guthrie and Steele, Attorneys in New York . 2, 183 Fees to Ashurst, Morris and Crisp, Attorneys in London .... 1,500 Fees to accountants and brokers and miscellaneous expense 10,293 69,998 This is a selling- expense of 17^%. It is, to be sure, ex- ceptionally high, but it must be admitted that it has often subsequently been equaled. 1 A further limitation on the possibility of selling securities through dealers is to be found in the fact that the decisions of these dealers as to taking on new issues are frequently determined as much by their own position as by the intrinsic strength and salability of the propositions. If a banking house has already undertaken as much as it can carry through, it will not entertain any other propositions to sell securities until it has cleared its shelves. Similarly, if it has already entered into arrangements to sell certain issues of a given type, it will not be in position to take on new issues of the same type. For its own safety, it would prefer to offer to its customers a diversified list. It has sometimes happened, for these reasons, that a really excellent proposition has been refused by houses which would otherwise have been glad to take it up. STOCK EXCHANGE METHODS 266. The Stock Earlier in the chapter it was remarked that when security issues of great size are to be floated, it is generally advisable to 1 Figures from Dewing on Corp. Prom, and Reorg., p. 419. 830 CORPORATE FINANCE [Bk. II- have them at once listed on the stock exchange and to effect at least a portion of the sales through stock exchange transactions. One advantage is that the ready marketability of the security is at once established. Another even more direct advantage is the fact that considerable quantities may be purchased through the exchange by people who are not listed as customers of any of the bond houses which float the issue, or who prefer to buy and sell through the exchange rather than "over the counter." Inasmuch as a full description of stock exchange methods would require more space than is available, it is only feasible to give here a brief review of the main features. Fundamentally an exchange is simply a meeting place for people who wish to buy and sell securities'. In the eighteenth century the London coffee houses grew to be the natural centers for business dealings, and gradually the custom arose of buying and selling through agents, who made it a point to meet for this purpose. It was a natural step forward to form an organization of these agents or brokers and to establish definite hours and fixed rules to govern the trading, and when that step was taken the stock exchange came into existence. Much the same series of stages has marked the evolution of exchanges in all the other principal commercial cities of the world. There are important exchanges today not only in London, New York, and Paris, but in Antwerp, Rotterdam, Buenos Aires, Rio de Janeiro, Val- paraiso, and numerous other cities. Within the United States the chief exchanges outside of New York, are in Boston, Philadelphia, Baltimore, Cleveland, Cincinnati, Chicago, New Orleans, and San Francisco. This is by no means a complete list. Even some of the smaller cities have stock exchanges of some importance. All the exchanges are organized on the same general plan. They are non-stock corporations, similar in their essential con- stitution to clubs. Members are admitted on payment of dues, provided a membership or "seat" has been purchased from some member who wishes to retire. The mere fact that membership Ch. 26] STOCK EXCHANGE METHODS 831 has been purchased, however, is not sufficient in itself to guar- antee admission. The membership committee may, for any reason that it sees fit, decline to accept the applicant. Seats on the leading stock exchanges, i.e., the right to deal in the exchange and enjoy its privileges, frequently sell at very high figures. Their value fluctuates widely from time to time, depending upon the amount and profitableness of the business which is being handled by the exchange. Seats on the New York Stock Exchange sold for $115,000 in the early part of 1920; a year later they brought but $88,000. 267. Brokers' Commissions The brokers who hold membership on an exchange are re- quired to charge standard commissions for buying and selling. On the New York Stock Exchange these commissions are as follows : On stocks selling below $10 per share ^% cents per share ^ On stocks selling at $10 per share and above, but under $125 per share 15 On stocks selling at $125 per share or over. ... 20 provided, however, that the minimum commission on an indi- vidual transaction shall not be less than $i. The buying and selling of securities on the large exchanges often reach an enormous volume; million-share days on the New York Stock Exchange are by no means uncommon. Natur- ally, much of this buying and selling is at once offset by a cor- responding resale or repurchase. A certain portion of the brokers are known as "scalpers" and make it their sole business to take advantage of quick fluctuations in prices. A broker of this type may buy 100 shares of stock with the full intention of reselling within a few minutes, or at any rate before the close of the day. He is satisfied if he makes a profit of %% to %% on the transaction, that is, $12.50 to $25. Other members of the Stock Exchange seldom or never appear on the floor, but operate entirely through their fellow brokers. 832 CORPORATE FINANCE [Bk. II- The advantage to them of membership lies in the fact that the regular commission on transactions for fellow brokers is reduced to a very low figure. By far the great majority of the brokers do little or no trading on their own account, but are satisfied with handling the orders given them by their customers. 268. Stock Exchange Settlements On the New York Stock Exchange the transactions of every day are "cleared" at the end of the day and settlements are made the following day. That is to say, purchases and sales of the same security are checked off against each other to avoid the excessive passing of certificates from hand to hand which would be the case if every sale were to be accompanied by an actual delivery. After purchases and sales have been checked there remains only a comparatively small residue of actual de- liveries required in order to close the day's transactions. 269. Speculative Dealings on the Exchanges The great mass of transactions on most of the stock exchanges have a speculative character. A great many securities, to be sure, are actually taken out of safe deposit boxes and brought into the market to be sold outright, and a great many securities are every day purchased to be held as permanent investments; yet the speculative buying and selling on the exchanges over- shadows investment buying and selling. The activities of the "floor traders" or "scalpers" who buy and sell for a profit of }/% to j^% have been mentioned. Many of these traders, though not all, make it a point to match all their purchases and sales before the end of every business day, thus reducing their risk of heavy loss to a minimum. These men proceed almost as much by intuition as by reasoning. If they see in the manner of bidding of other brokers, or "feel it in the air," that a given security is tending upward, they will help along the movement by making a purchase with the expectation of reselling a little later at a slight profit. One result of their Ch. 26] STOCK EXCHANGE METHODS 833 activities is to concentrate attention and the volume of trans- actions on a few active securities. Their business thrives on rapidity of fluctuation in prices. However, their operations tend to restrict the range of fluctuation, for they are ready to buy on a momentary drop in price or to sell on a momentary rise, and to resell or rebuy as soon as the normal level is again reached. A second group of speculators consists of brokers and of others who are in close touch with the Wall Street market arid who carry on buying and selling campaigns with the expectation of "cashing in" within a few weeks or months. Sometimes a group of these operators will form a syndicate or "pool" for the purpose of "bulling" or "bearing" the price of a particular security. Through "matched" orders for buying and selling they create an artificial activity and bring about great changes in quotations. Their cal- culation is that sooner or later outsiders will be attracted by the movement and will buy in. By gradually feeding out or repur- chasing the security in which they are interested, they may be able to clear a large profit for themselves. A third group of speculators consists of men who possess a real or fancied knowledge of the intrinsic value of a security, and who buy or sell when the market price is a considerable distance away from what they believe to be the normal price, in the expectation that at some later date the normal price will be reached and they may realize a profit. Included in this group are officers and directors of corporations the securities of which are listed on the exchange, who should be in position to know more about the real standing and probable future showing of their corporation than anyone else. Unfortunately for these men, it frequently happens that they do not give proper weight to gen- eral market influences which affect the whole level of security prices. Also it is not an uncommon case for a man who is thoroughly well acquainted with a given corporation, to form an entirely mistaken idea as to the market value of its securities. A fourth group of speculators consists of the "lambs" who are not equipped with the experience and insight of the "floor 834 CORPORATE FINANCE [Bk. II- traders," do not possess the knowledge of market conditions and financial resources of the larger operators, and are not acquainted with given securities as corporation officials are. For the most part they simply gamble on the strength of "tips" or of hazy impressions; and it can never be more than a temporary accident if they happen to make profits. The number of these people and the volume of their transactions is often exaggerated, but their losings nevertheless provide a steady source of revenue for the better informed and more skilful speculators. 270. Making a Market In disposing of the securities through stock exchange opera- tions, it is essential, first of all, that public interest should be aroused and that the volume of transactions should be of suffi- cient size to attract attention; otherwise the speculative buying, which constitutes the great bulk and which must be relied upon to take the new securities off the hands of the syndicate managing the flotation, will be lacking. "Making a market," as it is called, is accomplished chiefly through two lines of effort; first, by providing for a sufficient volume of transactions to arouse the interest of brokers and professional stock market .operators who will then buy and sell in the hope of making substantial profits out of the fluctuations. When the market has been brought to this point, the volume of transactions will become so large that the syndicate carrying through the flotation which probably will be engaged simul- taneously in buying and selling so as to maintain control over the price should find it possible to sell each day a little more than it buys. Thus it will gradually get rid of its own holdings without causing a fall in the price. At the same time, through direct sales outside the exchange, which will be facilitated by the excellent quotations on the exchange, it will probably dispose of the rest of its holdings. The second essential factor in making a market for a new security is favorable publicity. When the security is to be Ch. 26] STOCK EXCHANGE METHODS 835 brought out and listed on the stock exchange, for some weeks or possibly for some months in advance, the -financial press and the financial pages of the daily newspapers are liberally supplied with press notices intended to arouse glowing visions of the prosperity of the corporation. This aids both the stock ex- change activities and also the direct outside sale of the stock. 271. Limitations on Sale through Stock Exchanges On the basis of the brief description given, it is apparent that floating new issues exclusively through stock exchange operations is an uncertain process, and moreover is suitable only for securi- ties of a distinctly speculative character. The expense and risk of floating a comparatively small issue by this method are seldom justified. Just how expensive an operation of this character is likely to prove is a question that cannot be satisfactorily answered. It is evident, however, that even though it may be completely and quickly successful, there must be a large outlay for brokerage commissions alone. The buying and selling transactions must total a great many times the nominal value of the issue which is being floated, and the commission on each transaction may easily amount to a considerable sum. In addition, the risk undertaken by the underwriting syndicate must necessarily be recompensed by the possibility of earning a large profit. On the whole, it is questionable whether the average expense of sell- ing by this method is any less than by the other methods that have been described. In conclusion, it must not be understood that every new security which is listed on the stock exchange and immediately becomes active, is in process of flotation through stock exchange manipulation. It is often the case that the security is listed simply as an incident to its flotation, and is allowed practically to take its own course except for receiving some support from time to time in case its price tends to sag below the direct "over the counter" price. In this case the fact that the security is 836 CORPORATE FINANCE [Bk. II- listed, and that its quoted price is slightly above the "over the counter" price, is a -powerful and legitimate aid in selling the security. There can be no question but that any security which enjoys the advantage of being listed and of having a regular market is, for that very reason, worth more than a security of equally high intrinsic value which is not so readily marketable. , CHAPTER XXVII UNDERWRITING 272. Underwriting Contracts The practice of underwriting arose in connection with ship- ping ventures during the seventeenth century. The leading ship merchants of London were accustomed to assemble in Lloyd's Coffee House to transact their mutual business. In the course of time, the custom arose of dividing the risk of venturesome voyages among a number of different merchants, each one agree- ing to stand a fixed share of the loss or to receive a proportionate share of the profits. The contract to this effect was passed about and each merchant who agreed to it wrote his name under the contract hence the word "underwriting." As is well known, the term is used chiefly in relation to the distribution of insurance risks; though when applied to bond and share issues the essential thought is the same, namely, that of distributing the risk Perhaps it would be more correct to say that an underwriting contract for the sale of securities generally relieves the corpora- tion which issues the security of all risk. As will be explained a little later, there are a number of different types of underwriting agreements, but in all cases, as a main feature, a banking house or a group of banking houses undertakes that the corporation re- ceive not less than an agreed sum for the underwritten issue within a fixed period. The underwriters either buy the securities outright, or obligate themselves to take over the issue in case it cannot be sold to the public at the agreed price. 273. Advantages of Underwriting The advantages of this arrangement to a corporation are material. In the first place, an issue once underwritten by re- 837 838 CORPORATE FINANCE [Bk. II- liable brokers is an assured success. The corporation may at once proceed with whatever projects the fresh capital is designed to finance. There is no tedious and costly period of waiting dur- ing which the securities are in process of being sold. Many new enterprises are of such a nature that time is an important element in making them successful. If, for example, a new plant is being built in order to handle certain contracts, or if an effort is being made to forestall competition, it might be fatal to the project if progress must be delayed until securities were sold. A second highly important advantage is that a sound under- writing assures success in raising the entire sum required. Fre- quently any amount less than the entire sum would be a burden rather than a source of strength to the corporation. For exam- ple, a company operating department stores intends to establish a new store on a large scale in another city. The stores previously owned are developed as far as can profitably be done. To estab- lish the proposed new store with insufficient capital would be merely to make it second-rate and to invite quick failure. Let us suppose that the company needs $1,000,000 for the new store; that it authorizes an issue of additional stock for that amount, but sells only one-half the stock, thus raising $500,000. It is then in a position where it can go neither forward nor back- ward. It cannot very well return the money which has been raised, nor can it proceed with the new store. It is possible, in a case of this kind, to take subscriptions to the new issue under the agreement that they shall not be binding unless the complete issue is subscribed for within a given period. However, this in- troduces an element of uncertainty that interferes with the sale of the securities. A reliable underwriting protects the corpora- tion against all risks and difficulties of this nature. It can be certain of receiving the amount of capital that is agreed upon within a definite period. Incidentally, the underwriting method of marketing securi- ties carries with it the co-operation of the banking house that is to market the corporate securities. The corporation thus gets Ch. 27] UNDERWRITING 839 the benefit of the specialized experience and judgment of the bankers as to the form, price, and other details of the new securi- ty, and the possibility of mistakes is thus reduced to a minimum. Not only is the underwriting agreement advantageous to the corporation which issues the securities but also to the purchasers of these securities. The mere fact that an underwriting syndicate has been formed provided it is made up of first-class houses is in the nature of a guaranty that the securities are sound. Even more important is the guaranty that the issue will be sold in ac- cordance with the predetermined plan and the money secured be made available for the corporate purposes, for it must be borne in mind that the moment the purchaser becomes a stockholder or a bondholder in the corporation, he begins to share in its good or evil fortunes. If, therefore, the new securities sell slowly, or perhaps are not entirely disposed of, the injury to the corporation is also an injury to the purchaser of the securities. 274. The Underwriting Syndicate We have seen that originally underwriting consisted in the dis- tribution of the risk of a venture among several different mer- chants. This remains a characteristic feature of present-day financial underwriting. It is true that the term is frequently ap- plied to an agreement between a corporation and a single banking house, under which the banking house agrees to take over a block of securities at a given price. A transaction of this type may better be called a sale or, at any rate, a contract of sale rather than an underwriting. However, an arrangement of this kind, in which only one banking house is involved, is practically unknown except to cover issues of small size. A foreign government loan of as much as $6,000,000 was recently "swallowed" to use the bankers' own term by a' single banking house; but ordinarily only issues of less than $2,000,000 to $3,000,000 are taken up by an individual house. Usually, however, the original agreement is made between the corporation and a single banking house, which thereupon in- 840 CORPORATE FINANCE [Bk. II- vites other banking houses to join with it in floating the issue, each taking an agreed proportion of the risk and profits. These houses, together, form the underwriting syndicate. There are two reasons which make it preferable for a banking house to participate in a number of underwriting syndicates rather than to undertake fewer underwritings in which it assumes for itself all of the risk and all of the profits. The first and obvi- ous reason is in order to minimize risk. When many are inter- ested, a false step in a syndicate and even the ultimate failure of the syndicate would not prove ruinous; whereas the failure of one good-sized issue in which but a single house was concerned might not only tie up enough capital to wreck the house finan- cially but might also wreck its reputation, which is an asset of even greater importance. The second motive for preferring syn- dicate participation is that it enables the bond and brokerage houses to offer to their customers a well-diversified list of securi- ties. The general retail security dealer should be prepared to deliver any kind of security customers fancy, just as the de- partment store is ready to sell anything from pins to motor cars. 275. Community of Interest among Underwriting Houses If one banking house closes a good contract for an issue of securities .with an excellent chance of profits, others are usually invited to come in as members of the underwriting syndicate. In this way all of the more prominent banking houses of the par- ticular financial center participate in all the more important underwritings. There is of course no formal agreement to this effect, but it is tacitly understood that when one house permits its neighbor and rival to join in a profitable underwriting, the favor is to be returned at the first opportunity. So well-under- stood is this arrangement, that frequently in the Wall Street district at least, and probably in other centers the firms which become members of an underwriting syndicate are scarcely con- sulted. The banking house which has made the agreement with the corporation and which is managing the syndicate, simply dis- Ch. 27] UNDERWRITING 841 tributes the issue as it thinks best and notifies each of the partici- pants making up the syndicate. Most of these somewhat per- emptory invitations are profitable, and it is safe to say that invi- tations of this kind from one of the three or four most important banking houses are but seldom, if ever, refused. In testifying during the course of the Hughes investigation, J. P. Morgan, the elder, explained that several highly important syndicates involv- ing tens of millions of dollars were organized by his firm through the simple process of calling up the selected list of participating houses on the telephone and notifying them how much each was expected to take over. An important result of this "community of interest" is that it eliminates any keen competition for underwritings among the leading banking houses. It is comparatively of minor importance whether one house or another carries through the negotiations with the issuing corporation and becomes the active manager" of the syndicate, because in any case each of the important houses will participate in the syndicate and in a fair share of the profits. 276. Results of Community Interests In New York it is well understood that negotiations for the flotation of any large issue of securities should be taken up with only one of the important banking houses at a time. In case negotiations with one house fail definitely, they may possibly be taken up with another house. But the important banking houses will not directly compete with each other; nor will one of them even interfere with suggestions or investigations while another has the matter in hand. Much the same kind of a tacit under- standing exists in most financial centers. Many business men who are accustomed to dealing under highly competitive condi- tions resent the existence of this invisible and indefinite bond of union among the large underwriting houses. If they are bringing an issue into the market to be sold, naturally they would like to have it eagerly bid for. They are looking for competition and they find a silent, but inflexible understanding. CORPORATE FINANCE [Bk. II- The bankers, on the other side, claim first of all that un- checked competition would be disastrous not only to them, but also to the whole business community which they serve. It would mean reckless extension of credit, overfinancing, and dis- regard of conservative principles. They also claim that they make no oppressive terms or restrictions, and that there is no monopoly. Finally, they assert that the relations between the financial managers of a corporation and the banking house which handles their securities ought to be of an intimate, permanent, and semi-professional nature. A corporate official entrusted with the sale of his corporation's securities ought to select a banking house for his underwriting in which he has implicit confidence, just as he picks out a physician or a lawyer in whom he has confi- dence, and once selected ought to stick to his banker until that confidence is shaken or there is some real reason for a change. Th'en he should cut off all relations as quickly as possible and entrust his financial affairs to some other banking house. In other words, the banker is rendering a personal and partly pro- fessional service rather than merely buying and reselling a certain commodity. 277. Syndicate Agreements There are four distinct types of agreements between the underwriting syndicate and the corporation which puts out the underwritten issue. Possibly other variations from these basic types might be found. i . The corporation may itself sell the issue and the syndicate simply insure that the whole issue will be disposed of within a given time at a minimum price. The corporation, we will say, is bringing out an issue of $1,000,000 6% bonds, which it offers at par. The underwriting syndicate agrees that it will take any bonds left unsold at the end of the year at a special price of 90. The syndicate would, perhaps, receive a commission of 2% to 5% for making this agreement. If the issue were successfully sold, the syndicate would merely collect and distribute its com- Ch. 27] UNDERWRITING 843 mission and dissolve. If the issue at the agreed price were un- successful, the syndicate would take over the unsold balance and dispose of it as best it might. This type of agreement is now un- common except when a corporation has given a subscription privilege to its own shareholders and is apprehensive that the offering will not be taken up in full. 2. A banking house may conclude an arrangement with a cor- poration to handle the sale of a block of its securities and may afterward call in other banking houses to take over certain pro- portions of the risk and of the profits. The corporation, however, has no dealings with the syndicate as such, but only with the original underwriter which becomes the manager of the syndicate. 3. The syndicate may be formed before a final agreement with the corporation is signed, and the agreement be directly between the corporation and the syndicate, though the manage- ment of the whole transaction and the actual selling of the securi- ties may be left in the hands of the one banking house which has taken the initiative. This banking house carries through the sale of securities and does not distribute them to the other mem- bers of the syndicate unless the sale fails in whole or in part. 4. The agreement is made between the syndicate as a whole and the issuing corporation, and the securities are at once dis- tributed among the members of the syndicate in proportion to their participations. This form of underwriting is almost in the nature of a joint purchase, each of the banking houses being ex- pected to act independently in disposing of its proportion of the issue. This is perhaps the most common and most useful type of agreement for handling large issues. It is clear, from the varying descriptions above given, that the term "underwriting" is used in a loose sense. It is, in fact, often difficult to distinguish in practice between the underwriting of a block of securities and its purchase. Even when a single banking house takes over outright a complete security issue and pays the corporation an agreed price, the transaction is com- monly referred to as an underwriting. 844 CORPORATE FINANCE [Bk. II- 278. The Syndicate Manager Whatever the type of syndicate issue may be, there is always this common characteristic : that the active management is un- reservedly in the hands of the banking house which organized the syndicate. In the published agreement, for example, of the United States Steel syndicate it is provided that: J. P. Morgan and Company shall be sole managers of the syndicate, and in behalf of the syndicate they may make any and all arrangements, and may perform any and all acts, even though not herein provided for, in their opinion necessary or expedient to carry out the provisions of this agreement; or to promote or to protect what they deem to be the best interests of the syndicate. The enumeration of specific powers in this or any other article of this agreement, shall not be construed as in any way abridging the general powers of this article intended to be conferred upon or reserved to J. P. Morgan and Company. Throughout this agreement other reservations of the same general character abound, and in this respect the contract is typical of most underwriting syndicate agreements. In return for its special efforts the managing house usually receives a commission as manager, which is deducted from the syndicate profits before distribution of the remaining profits. This payment to the managing house varies a great deal, depend- ing on the profitableness of the transaction. It will probably average i% to 2% on the par value of the block of securities. 279. Underwriting Commissions The commissions of underwriting syndicates may vary all the way from i^% to 10%, or even more. If the commissions are high, it is quite the custom to make them payable partly in securi- ties. In 1910, for example, the newly organized International Cotton Mills Corporation was in need of working capital, which it secured by selling to Blair and Company $2,000,000 6% 5-year notes at par, in consideration of a commission of $1,000,000 par value of the corporation's common stock. These notes were offered to the public by Blair and Company at 98. In 1898 the Ch. 27] UNDERWRITING 845 Union Pacific Railroad Company paid a syndicate $5,000,000 of preferred stock, then quoted at 59, for underwriting a subscribed capital of $15,000,000. This amounted to a commission of ig%. 1 These examples refer to companies which at the time did not have a high credit standing, and are not to be taken as typical. In the underwriting of $20,000,000 face value of the common stock of the American Woolen Company, in 1920, the price to the public was par; to the underwriters, 95. 280. Speculative Underwritings Most of the preceding remarks in this chapter refer to the underwriting of high-grade bond and preferred stock issues by financial houses of the highest standing. However, this is by no means the only situation in which underwriting is undertaken. In addition to disposing of large blocks of securities for estab- lished corporations, syndicates may be formed for the purpose of underwriting the issues of new or of reorganized corporations. In any of these cases the issue that is being brought out may be of a speculative character and the syndicate itself may be far less stable and more speculative than has been assumed in what has been said above. Frequently underwriting syndicates are made up, not of first-class banks or banking houses, but in whole or in part of individuals and of second-rate houses. 281. United States Realty and Construction Company A striking instance of such underwriting was that of the United States Realty and Construction Company: 3 In 1902, prominent financial interests in New York promoted a consolidation of real estate building and owning companies, known as the United States Realty and Construction Company. The promoters having been impressed with the speculative enhance- ment of New York realty values wished to obtain a large fund of Railroad Reorganizations, by Stuart Daggett, pp. 347, 348. 1 The description of this underwriting is taken by permission from 2 Dewing on Pinan. Policy of Corp., pp. 114, 115. 846 CORPORATE FINANCE [Bk. II- ready money which could be used in building construction and speculative ventures. Some of the best known and ablest finan- ciers of the country were led to lend their financial and moral support to the enterprise. Mainly through the efforts of James Stillman, of the National City Bank, a syndicate was organized to supply $i 1,000,000 in money to the new company. The syndicate received $11,000,000 in the preferred stock and $11,000,000 in the common stock of the United States Realty and Construction Com- pany in return for the money. Of the $11,000,000 subscribed by the members of the syndicate, 20 per cent was immediately paid in money, 60 per cent was paid by their notes, and banks arranged to carry the remaining 20 per cent in the form of a loan, the syndicate securities being used as collateral. So popular and, in the past, so profitable had the underwriting of new industrial promotions proved to be, that the right to subscribe to the syndicate was looked upon as a privilege. A financial journal of New York stated that "nearly every important financial interest in this city" subscribed to the syndicate. The number included the Equitable and New York Life Insurance companies, the National City, and other prominent banks and trust companies. Messrs. Hallgarten and Company acted as managers, receiving for their services 2 per cent of the total subscriptions, or $220,000. Just a year after its formation the syndicate was liquidated. During the period of its duration the managers had bought and sold both the preferred and common stocks of the United States Realty and Construction Company and had collected approximately $500,000 in dividends. As a result of these operations the sub- scribers to the syndicate received for each $1,000 of original sub- scription, $1,155 P ar value in preferred stock, $702 par value in common stock, and $16.66 in money. These securities had, on the day the syndicate was liquidated, a value, including the money, of $523.09 for each $1,000 original subscription, or approximately one-half what had been subscribed the year before. If the interest on the subscription should be deducted, the returns to the members of the syndicate were actually less than one-half the original sub- scription. 282. Underwriting of United States Shipbuilding Company An even more disastrous underwriting failure was that of the United States Shipbuilding Company. The promoters were re- Ch. 27] UNDERWRITING 847 quired to sell enough first mortgage bonds to produce $7,500,000 in cash. To meet this requirement $4,250,000 of the bonds were underwritten in France at 90, and $4,750,000 were underwritten in this country. The public offering of the bonds was, however, a failure, inasmuch as only $500,000 out of the total offering of $9,000,000 was subscribed for. The promoters of the consolida- tion therefore fell back upon the French and American under- writings of the bonds. The American underwriters stood back of their subscriptions and accepted about $4,500,000 of the bonds at 90. Most of the French underwriters, however, who were not bankers but indi- viduals untrained in business affairs, declined to meet their alleged obligations. They asserted that those in charge of the matter in this country had assured them that their underwritings would never be called and had later cabled them that the public offering of the bonds was a success. The promoter of the con- solidation went to Paris in a strenuous but unavailing attempt to secure payment from the French underwriters. Meanwhile large loans had been made in this country on the strength of the French underwriting, and when this underwriting failed to mate- rialize the results were calamitous, involving the failure of a prominent trust company identified with the underwriting, and the suicide of one of the more prominent participants. 283. Underwriting of the American Woolen Company A more recent underwriting failure was that of the American Woolen Company in 1920. The company decided to issue an additional $20,000,000 face value of common stock. This was first offered to the stockholders of the company at par, on the basis of one share of the new stock for every three shares of stock owned by the shareholder. Any stock not taken by the share- holders was later to be sold to the public at not less than par. The stock was underwritten by a group of New York bankers at 95. But a small percentage of the stock was purchased by the company's stockholders and the outside public, and, accord- 848 CORPORATE FINANCE [Bk. II- ing to the newspaper reports of the day, the underwriters were themselves forced to purchase over f 18,000,000 face value of the new stock at the underwriting price of $95 a share, and this at a time when the stock was quoted in the open market at $62.50 per share. Part V Internal Financial Management CHAPTER XXVIII BORROWED CAPITAL 284. Advantages of Borrowing "The habit of borrowing," says Hartley Withers, "is a mod- ern invention." There was formerly a custom among all well- ordered governments and business enterprises, of amassing treas- ure for use in emergencies; without hoarded treasure even the largest owner of property would have been helpless. Today the wisest financial policy is to pile up not treasure, but credit. To be sure, sound credit may require the possession of a certain pro- portion of gold and securities ; but this treasure no longer exists for its own sake so much as for a support and guaranty to credit. More and more as credit facilities increase and credit machin- ery works more smoothly, business enterprises are financed with borrowed capital. The great advantages of borrowing are its cheapness and its ease. It is cheaper to borrow than to secure a co-owner or a group of co-owners for a business, because of the greater security that is offered to the lender. To put the same thought in terms of corporate financing, first-class bonds may be sold on a 5% or 6% basis, whereas preferred shares of the same relative standing sell on a 7% or 8% basis, and common shares on a still higher basis. Hence the larger the proportion of capi- tal which the individual or corporation can borrow, the larger is the yield on the owned capital. Take a very simple illustration. Suppose a corporation with $100,000 capital is regularly earning 10%, or $10,000, a year; let 840 850 CORPORATE FINANCE [Bk. II- us say that $20,000 of the capital is borrowed at 6%, making the interest payment $1,200. Then the $80,000 of owned capital will have left an income of $8,800, or 11%. Let us now make the assumption that the business is of such a character that $80,000 can be borrowed at 6%, making the annual interest payment $4,800. In that case the $20,000 of owned capital will have left an income of $5,200, or over 25%. We have here an explanation of the profit-making possibili- ties when properly financed of enterprises which yield only a small average return on the invested capital. Most public utility companies, for instance, secure only a moderate yield on their actual investment, but they hold properties which can be mort- gaged up to a high percentage of their value. Hence, at least one-half the capital is borrowed and the owned capital may ob- tain very good dividends. An illustration of this practice and its results in this particu- lar case at least is afforded by the Kentucky Utilities Company, subsidiary of the Middle West Utilities Company, which had out- standing January i, 1921: Common Stock ...... w JlUafl $1ooo Preferred Stock ____ : .^ij.ij.; .U.lol 2& /bum i- 755,000 Funded Debt .............................. 5,216,100 This funded debt bears 6% interest. The net earnings of the company for 1920 before payment of any interest were $591,588, This was disposed of as follows: Total Net Earnings. . .'! /v.''.'!Y / .V:V. .......... $591,588 Interest on Bonds and Other Indebtedness ..... 361,537 , Balance $230,05 1 Preferred Dividends, at 6% $ 44,775 Common Dividends 150,000 $194,775 Balance to Surplus $ 65,764 In other words, the dividend rate on the common stock was two and one-half times the interest rate on the funded indebtedness. Ch. 28] BORROWED CAPITAL 851 285. Ease of Borrowing As to the ease of borrowing on a good bond or short-term note, it is perhaps sufficient to call attention to the immense quantities of bonds and notes which are continually being issued and sold. Modern efficiency and productivity are piling up wealth at a faster rate than ever before. And the security of property except as it may be disturbed by tremendous inter- national conflicts is increasing. Now, the first thought of a man who has only a little money is to increase that little, and he is willing to take chances in so doing. Security does not appeal to him so strongly as the prospect of profits. For that reason, it is among poor people, and especially poor people of the profes- sional classes, that the swindling promoter finds his easiest vic- tims. But a man who has a comfortable amount of property wants security first of all he is looking for safety rather than for large returns. Hence, as the average wealth of a country increases, not only is more and more capital released for invest- ment, but a larger proportion of that capital is looking first of all for safe investment. In other words, its owner prefers to lend it rather than to take greater chances as a proprietor or part proprietor. Another factor working in the same direction, is the piling up of enormous funds held in trust; estates that are being directed by trustees; the funds of life insurance companies; the funds of savings banks and the like. All these trust funds" are available only for lending on excellent security. For these reasons a man or a corporation which can put enough owned capital into a sub- stantial enterprise to furnish a reasonable margin of safety, will generally find it a comparatively easy task to borrow the remain- der of the needed capital. What has been said applies more especially to long-term or "funded" borrowing, but much the same statements hold true of short-term borrowing. It is a fact that more capital is needed today than used to be needed, but notwithstanding this, an indi- vidual does not need more money to go into business. 8$ 2 CORPORATE FINANCE [Bk. II- The explanation for this apparent paradox is to be found in the free use of credit which is a striking characteristic of all present-day business enterprises. Manufacturers, wholesalers, and bankers are always ready to extend credit freely to men of ability and character. The silk industry because of its use of credit is notable for the amount of business that can be done on a very slim margin of capital. Raw silk is sold to manufacturers on a credit basis that resembles "memorandum credit" among jewelers. Many of their factories are not owned but rented en- tire. It is said that the extensive cotton industry of Philadelphia is in large measure carried on in the same way. Lofts with power and machinery are rented; materials are obtained on a credit basis. Much the same conditions obtain in the shoe business. The United Shoe Machinery Corporation has for many years made a practice of furnishing its machines only on lease ; it does not sell them. In this industry, therefore, a man with large capi- tal has no great advantage, so far as obtaining efficient machinery is concerned, over a man with small capital. 286. Risk of Borrowed Capital Against the two great advantages of borrowed capital cheapness and ease in procuring the funds there must be offset the obvious disadvantage, that the risk to the owners of the share capital is thereby increased. The shareholders have, of course, only an equity in the property and income of the corporation which is first subject to all prior claims of the holders of the obli- gations. This may not involve a serious risk in the case of cor- porations that have stable earnings, but when earnings fluctuate widely from year to year, even though the average return on the invested capital may be high, the position of the shareholders with a large indebtedness ahead of them may become very un- comfortable. It is for this reason that the tendency has been strong in recent years for industrial corporations to shun even small bond issues and to raise their capital only through common Ch. 28] BORROWED CAPITAL 853 and preferred shares. Sometimes this cautious policy may be carried to what appears to be an extreme. Some of the large and powerful industrial corporations of the country have no securities outstanding except stock. This is true, for instance, of the Singer Manufacturing Company with $90,000,000 of common stock, and neither preferred stock nor funded indebtedness beyond this. Likewise, the Mergenthaler Linotype Company has no funded obligations, and no outstand- ing stock save common stock. The same may be said of the. Ford Motor Company, and it was also true of the Pullman Car Com- pany up to the time of its consolidation with the Haskell and Barker Car Company, Inc. Among the corporations having common and preferred stock outstanding but no funded indebt- edness, may be mentioned the United Shoe Machinery Corpora- tion, National Cash Register Company, and the Standard Steel Car Company. The unsoundness of too heavy borrowing cannot be better shown than by the combined figures on the capitalization of thir- teen large railway systems in the United States which were in receivers' hands in the summer of 1914. The funded debt of these thirteen railways was about 70%, and the stock issues only about 30% of their total capitalization. 287. Rules for Borrowing ^ . To lay down any exact rules as to the proper proportion of borrowed capital, would clearly be out of the question. In ordin- ary short-term bank borrowing the generally accepted ratio of quick or current assets to quick liabilities is two to one. In long- term borrowing the conditions must govern in each case. It may be said generally, however, that capital should not be borrowed unless there is a practical certainty that both interest payments and payments on principal can be met as they fall due. This in- volves the further rule that the annual fixed payments of a cor- poration should be limited to a reasonable proportion, not of the average earnings, but of the lowest probable earnings. The fact 854 CORPORATE FINANCE [Bk. II- that a corporation has made a distribution or invested big profits in one year, is small comfort if it finds itself in the following year unable to meet its obligations. As to payments on account of principal, it has long been re- garded as almost axiomatic that companies doing a stable busi- ness, such as railways and public utilities, need make no provision for paying off and permanently retiring their funded debts. These companies, it has sometimes been said, will never cease to borrow; therefore, when one obligation matures, the proper plan is to refund it by issuing another obligation in its place. 1 288. Forms of Borrowing All borrowing is of two general classes, "short-term" and "long-term." This is by no means purely a verbal difference, for there are clear market distinctions between the principles that apply in these two classes. Just where we should draw the line between the two is a difficult question to answer; it is largely a matter of usage. In Wall Street, "short-term" usually refers to obligations having not more than five years to run; "long-term" usually refers to obligations having, say, twenty years or more to run from date of issue. Obligations running in intermediate periods might be put in either one or the other of the two groups, according to conditions. Short-term securities consist of notes, of acceptances, and of accounts payable. The notes are divided into three well-marked classes: (i) merchandise notes, (2) notes discounted at banks, and (3) notes sold to the public. For our present purpose, we will group accounts payable, acceptances, and merchandise notes under the head of "trade credit." After considering this subject, we will take up bank credit. This is a convenient division of short-term borrowing which conforms to commercial practice. Short-term notes sold to the public have already been consid- ered. 2 1 For further discussion of this subject, see 82, "Maturity of Bonds." 1 Ch. X, "Short-Term Notes." Ch. 28] . BORROWED CAPITAL 855 289. Trade Credit The fact that all the trade credit which a business normally utilizes is in fact a method of borrowing capital, seems to be over- looked; yet it is the chief source of capital in many concerns which do a trading business. There are literally tens of thousands of small merchants throughout the country who customarily buy nearly all their stock in trade on credit, and whose own capital is no more than sufficient to cover the purchase of store fixtures and perhaps some small advances on their first orders as a guar- anty of their good faith. It is out of the question for them to pay their accounts with the wholesalers from whom they buy, until after they have sold the goods and thus have secured cash funds from their customers. Very often the wholesaler in his turn is "carried" to a great extent by the manufacturers and jobbers from whom he buys; his proportion of owned capital, however, is likely to be much higher than the retailer's propor- tion. Going one step further back we reach the manufacturer with whom trade credit is comparatively a minor source of funds. Thus we have the whole process of selling goods through the ordinary trade channels financed to a considerable extent by the extension of credit. The ultimate customer is the only man in the chain who pays cash and even the customer may in his turn be living on trade credit. As the customer pays for his pur- chases, the retailer is able to collect current funds which he trans- mits to the wholesaler, who in turn pays the jobber and manu- facturer. 290. Extent of Trade Credit The extent to which trade credit is granted, depends chiefly upon the nature of the goods that are being retailed, and on the ability of the ultimate consumer to pay promptly. Prior to the Civil War, purchases of merchandise were customarily settled by notes running six, eight, or ten months and sometimes longer. This was due to the fact that buyers came to market only once or twice a year, and then purchased their entire stock for the 856 CORPORATE f INANCE [Bk. II- season, the buyers giving their notes which were readily indorsed and discounted. These were usually met out of the proceeds of the sale of the goods to the ultimate consumer. The Civil War upset this system. During the war and for some years after, merchandise business came down to a basis of cash or of credit of only 10 to 30 days. When the next great expansion of trade took place in the early eighties, the increased confidence of sellers re- sulted in offering somewhat longer terms of credit, but these terms were combined with offers of liberal discount for cash pay- ments, which is the custom in most lines today. The discounts were so attractive that retail merchants in good standing began to borrow from their local banks in order to take advantage of them. Thus the present practice of taking discount for cash was established; and prices were made with that understanding. The high rates of discount were in the nature of a penalty im- posed on a merchant who took the long terms which were nomi- nally at his disposal. At the time of the Great War a determined effort was made by manufacturers and jobbers to cut down the time of credit and eliminate or reduce the trade discount. Where time was desired the use of the trade acceptance was urged. These efforts were fairly successful as long as the "sellers' market" created by the Great War continued. Since then, time and trade discounts have both returned to practically their former position of importance. Because of the prevalence of the cash discount, trade credit in this country is relatively less important, and bank credit is more important, than was formerly the case. Another factor which should be mentioned as contributing powerfully to this result is the decentralized banking system of the United States, which puts one or more local banks at the door of every merchant and makes it easy for him to secure and utilize bank credit. 291. The Trade Acceptance The European system of financing merchandise purchases rests upon the use and discounting of accepted drafts which are Ch. 28] BORROWED CAPITAL 857 in effect two-name promissory notes. The wholesaler draws a time draft upon the retailer which accompanies the shipment of goods. The retailer writes or stamps his acceptance on the draft across its face and returns it to the wholesaler who is then in position to discount it with his bank. This is a method of financ- ing merchandise transactions which, from the banker's stand- point, has a number of advantages, the chief of which is that every accepted draft represents an actual transfer of goods, and the banker is not compelled to lend, therefore, merely on the strength of the general credit standing of his customer. Before and during the Great War a strong effort was made, under the guidance of the Federal Reserve Board, to introduce this system in the United States and to extend it to the consumer as well as to the retailer of goods. Although the movement is of genuine importance, we need not for our purposes consider it further. It is closely similar to the custom which prevails in certain lines of business of giving notes in payment for purchases of merchandise. Some of the principal lines in which note-giving is still com- mon are harvesting machines, plumbers' supplies, book printing and binding, and electric trolley supplies. In most other lines, however, goods are sold on open account and notes are asked for only when the sale is made to a weak concern. 292. Dangers of Trade Credit Sellers are often so anxious to dispose of their products, and it is consequently so easy for established firms with a clean record behind them to secure whatever goods they require on terms of 30 to 90 days or even longer, that trade credit may almost in- sensibly become a real source of danger. It is a delicate instru- ment which requires to be handled with watchfulness. A little carelessness in failing to meet trade accounts on the day they fall due may be sufficient to give a concern the reputation of being "slow pay," and thus may damage not only its credit with the firms from which it buys, but also its credit with banks and its general business standing as well. 858 CORPORATE FINANCE [Bk. II- 293. Danger of Too Prompt Payment of Trade Accounts Curiously enough, there is also danger in overzealousness in paying up trade accounts. Not only is there an actual loss of capital to the extent of the difference between a normal amount of trade credit and the amount which the company secures, but there is also to be considered the fact that the reputation of pay- ing accounts ahead of time, once established, involves a con- tinuance of the practice. The writer has in mind one concern which started in business with ample funds. The treasurer saw no reason why he should utilize the credit of the firm and paid all bills in cash as they were presented, even though he obtained no discount. A year or two later the expansion of the company's business reduced the available cash, and the treasurer began to take the full term of payment to which he was entitled. Im- mediately some of his creditors became suspicious as to the sol- vency of the company, and such serious rumors were spread about that it was necessary to bring more cash into the concern and resume, for the time being at least, the prompt payment of bills. Thereafter the company proceeded by slow degrees to utilize the full line of trade credit to which it was entitled. There is much truth in the remark that the only way to acquire credit is to make use of it, 294. Bank Credit It has already been noted that it is customary in this country for merchandising firms to take advantage of cash discounts in paying for their purchases and to secure the funds with which to make immediate payments by borrowing from their own banks. This practice spread throughout the country beginning in the eighties, but it originated in New York some years before. Shortly after the crisis of 1873, the president of the Importers and Traders National Bank, a Mr. Buell, rapidly built up the busi- ness of his institution by showing his customers how, by borrow- ing from his bank on their own single-name paper, they could obtain cash prices or cash discounts and thus show a substantial Ch. 28] BORROWED CAPITAL 859 profit on their interest and discount accounts for the year. The custom is now so firmly established that practically every busi- ness concern in good standing counts on establishing a line of credit with its bank which will enable it to borrow simply by drawing its own notes and depositing them with the bank. 295. The Work of the Note-Broker A variation of this custom is found among large manufactur- ing and commercial corporations which on occasion turn over their notes to brokers who for a small commission sell them to any bank that may happen to have idle funds available. These note-brokers sell the paper of large concerns throughout the country. At the time of the failure of the Booth Fisheries Com- pany a number of years ago, and later at the time of the failure of the H. B. Claflin Company and associated concerns, the notes of these companies turned up among banks in almost every part of the United States. At that time the banker who bought a single-name note from a broker, very often had no knowledge whatever of the financial affairs of the company which issued the note. He might have heard the name of the company frequently and he probably considered the note-broker a good fellow in whose honesty and judgment he had confidence, and that was the extent of the actual information before him when he made his purchase. This loose method of doing business has to a consid- erable extent worked its own cure, more conservative methods now prevailing. A few large concerns which sell their short-term notes in the open market on a large scale have instituted the custom of hav- ing all their notes registered by a trust company, just as bonds are registered. This has at least the advantage of making it easy to ascertain how many notes a company has outstanding at any one time, thus avoiding large overissues. The co-operative efforts of the member banks of the Federal Reserve system have also resulted in better credit methods, and the prevention of the grosser abuses. CORPORATE FINANCE [Bk. II- An accepted rule of safe finance which should be observed by corporations that sell their notes through brokers, is that they should not at one and the same time be discounting any large quantity of notes with both banks and brokers. If they are using both, they have no quick method of raising funds. If they are using either their banks alone or note-brokers alone, then they can turn, if it should become necessary, to the method that has not previously been utilized. 296. Reasons for Bank Borrowing There are three legitimate reasons for making bank loans : 1. To finance a temporary shortage of funds. 2. To increase by purchase the stock of salable goods on hand. 3. To enable the dealer to extend additional credit to cus- tomers. The first reason may be entirely acceptable to the banks, but only under unusual circumstances. A firm, for instance, may have suffered a loss by fire and have insurance payments shortly due, in anticipation of which it may properly borrow from its bank; or it may have funds shortly coming in from its stock- holders or from other sources. Each case of this kind must be decided on its own merits. The second reason for bank borrowing is the one that is cus- tomary and that is generally considered soundest. It is, of course, necessary for both the borrower and the bank to be reasonably certain that the goods being purchased are salable, so that there may be no question as to meeting the indebtedness out of the proceeds of the sale. The third reason is also concerned with the sale of goods, but this time from the standpoint of the seller. It is necessary here for both the borrower and the bank to make sure that the credit which is being extended to its customers, is both well placed and sound. Ch. 28] BORROWED CAPITAL 86 1 297. Abuse of Bank Credit The abuse of bank credit has long been a weak feature of modern business life, and will not quickly be eliminated. It may arise in two ways : 1. By making a wrong application of the funds secured from the bank. 2. By obtaining funds on the strength of false or question- able claims. If the borrower, instead of using the funds he receives from the bank for one of the three purposes above mentioned, utilizes it in extending his plant, in the purchase of non-salable goods, in general advertising, or puts it into any other property or expendi- ture that is not readily convertible into cash, he may properly be said to be abusing the trust of his banker. More than that, he is seriously jeopardizing his own financial safety. "What difference does it make to the banker whether I use his money in one way or another?" is the answer of some business men; "Sooner or later he will get his money back with interest, and that's all he needs to fret about." Yes, but the banker is not in the business of making long-term loans or loans that may be sound enough but cannot be paid back on the dot. The only safe banking is short-term banking, and he is absolutely right when he insists that his loans be used only in quick turns and not for permanent or uncertain investments. But little need be said about the second abuse of bank credit. The insistence of banks on full financial statements from would- be borrowers and the enactment of laws making any material misrepresentation in these statements a criminal offense, have ended the grosser abuses in this direction. 298. Bank Collateral We have spoken in the preceding section of bank credit as if it were always obtained on the strength of a company's standing. This is, in fact, the case when a concern borrows simply by giving its unsecured note, and even when it indorses and discounts a 862 CORPORATE FINANCE [Bk. II- note which it has received from some customer who is practically unknown to the bank. Bank credit is even more extensively obtained, however, when it is directly backed by collateral security of some kind. Such loans are more easily granted, not only because the banker calculates that he is secured against loss, but also because he has a better check on the uses to which his money is to be put. Collateral may be conveniently classified under three heads : 1. Stocks and Bonds 2. Merchandise 3. Accounts Receivable 299. (i) Stocks and Bonds as Collateral As security for loans, stock and bonds are the banker's favor- ite, at least in the United States. This is due to the fact that the stocks and bonds available as collateral are usually salable, so that in case of default on the part of the borrower, the banker has little difficulty in disposing of the collateral and repaying most or all of his advances. This statement is not to be taken as apply- ing indiscriminately to all stocks and bonds ; for the securities of some local or little known companies, even though the companies may be carrying on a successful business, are about as unmarket- able property as can be mentioned. At the other extreme are the active securities of the great corporations which are being daily bought and sold in large quantities on the New York and other stock exchanges; these are the securities that serve as collateral for the enormous amounts of call loans kept outstanding by the banks of the New York financial district. Between these two classes of collateral there are many sound securities which the banker regards as at least fairly marketable, and which he is willing to take as collateral. Some of these securi- ties are owned by commercial and manufacturing corporations which may properly use them as a basis for bank credit. There is, however, a limitation to be noted here. It is not regarded as sound practice for a corporation to post as collate/a! the stock Ch. 28] BORROWED CAPITAL 863- of a subsidiary company. In the first place, the stock probably has no active market and the bank will accept it only reluctantly and when it is mixed with salable collateral, and in the second place, the corporation should not be compelled to take any chance even a remote chance of losing control of an essential piece of property. The securities of subsidiary companies may serve properly as collateral for long-term bond issues, but not as col- lateral for bank loans. 300. (2) Merchandise as Collateral Merchandise serves as collateral when a company posts ware' house receipts, bills of lading, or specific liens upon specific piece? of its personal property as collateral. The first-named case is" the one that is most common. Millions of dollars of holdings of cotton, wheat, and other grains are carried in this way every year following the harvesting of the crops. Once in a while manufacturing corporations may have collateral of this nature, as when a steel manufacturing company holds pig iron, but this is unusual. Bills of lading, indorsed to the order of the bank, commonly serve as collateral for drafts discounted by the seller of merchandise. Millions of dollars' worth of goods in transit are in this way utilized as backing for loans made by the banks, and accepted as collateral up to a fair proportion of their value. This is particularly true in the export trade where the banker does not feel sure enough of the standing of the drawer of the draft or of the salability of the merchandise to risk discount- ing the whole draft, but is willing to make advances up to, say, 50%, 60%, 80%, or more of its face value. This is true also when the merchandise consists of goods that are perishable or that do not have a ready market. A draft, covering a shipment of fruit, for instance, might not be readily discounted, but sev- eral of these drafts would be regarded as good collateral for an advance of, say, 50% to 75% against their face value. Liens on specific pieces of personal property are not common, but may at times be perfectly good banking collateral. 864 CORPORATE FINANCE [Bk. II- 30* (3) Accounts Receivable as Collateral Accounts receivable fall into a different class. The evidence of indebtedness of a third party to the borrower is so uncertain and the claims upon specific property are so indirect, that ac- counts receivable are not customarily accepted as sound collateral for a bank loan. It is considered better for the company to bor- row on its general credit rather than to assign its accounts receiv- able as collateral. As a result of the unwillingness of most banks to accept assignments of accounts receivable as collateral, a con- siderable number of financing and discount houses have come into prominence during the last few years, which make a specialty of advancing money against open accounts. 302. Factors Considered by Banks in Making Lpans The underlying principles followed by the banker in extend- ing credit have been touched upon in the two preceding sections. It is important to bear in mind particularly: 1. That the commercial banker must confine himself to making short-term loans. 2. That he should satisfy himself that the money he loans is to be invested in such a way that it can readily be reconverted into cash. 3. That credit granted on the general standing of a business enterprise entitles the banker to a full and detailed statement of the company's financial standing. 4. That collateral, to be acceptable to a banker, must con- sist either of securities and merchandise which are readily salable, or of drafts which are quickly convert- ible into cash. Among the factors considered by banks in making loans, must necessarily be the legal restrictions in force at the time. The banking law which went into effect in 1914 provides that "any Federal Reserve Bank may discount notes, drafts, and bills of exchange arising out of actual commercial transac- Ch. 28] BORROWED CAPITAL 865 tions." The effect of this law is to increase the value of two- name paper, accepted drafts, and other evidences of debt, which are the direct results of commercial transactions, and correspond- ingly to decrease the value of paper which is not available for re- discounting at Federal Reserve banks. Under this law, the paper issued by one subsidiary company to a holding company as an accommodation note such as the 30 to 40 million dollars of Claflin notes previously referred to would not be available for rediscounting. One result of the collapse of the Claflin firm was to strengthen greatly the movement in favor of putting a premium upon paper which arises out of commercial transactions. 303. Bank Customs as to Loans Among the unwritten rules that have long been customary among bankers in making loans, these two are of chief impor- tance: 1. Of the amount loaned by a bank, 15% to 25% should be left in the bank on deposit, the other 75% to 85% only being available for meeting obligations. This is a long-standing cus- tom, but is not universal. It is more strictly applied by some banks and in some lines of business than others. When a line of credit is granted, the company to which it is granted is expected at all times to keep an amount on deposit equal to from 15% to 25% of the total credit. 2. All bank loans should be "cleaned up" at least once a year so that the bank may make sure that the money it lends is not going into permanent investments. This is especially neces- sary in those lines of business which have well marked seasons of activity. It would be clearly inadvisable for a bank to allow a customer in such a line credit for the coming season until after he has paid up his loans for the previous season. With manu- facturing corporations the rule is not so strictly applied ; yet even here it is desirable that the company's balance sheet should once in a while be wiped clear of bank loans. If this cannot be done, it is clear enough evidence that the company is using bank funds 866 CORPORATE FINANCE [Bk. II- as a part of its permanent capital, which it is obvious should be reinforced by the sale of more stock or long-term securities, not by bank loans. 304. Banker vs. Borrower All these rules of successful and conservative banking are also the rules of successful and conservative financing of all busi- ness corporations which borrow from banks. There is no con- flict whatever between the two points of view. A banker wishes in normal times to lend as much as he can safely place ; the treas- urer of a borrowing corporation wishes to borrow as much as he can safely carry. In theory there should never be a disagreement or a hitch between them. However, the frailties of human nature are not so easily set aside. A treasurer's prejudices and fancied interests frequently lead him to oppose reasonable requests and criticisms; on the other hand, a banker is at least equally liable to suffer from obstinate prejudices. Recently an eastern manu- facturer asked his banker for a loan of $25,000. "I see," said the banker, looking over the manufacturer's statement, "that your advertising expense for last year just about equals $25,000. If you would cut off your advertising you would have all the money you need." The manufacturer tried to explain that it was neces- sary for him to advertise in order to sell his goods, and that the money borrowed from his bank was required in order to purchase raw materials which would be quickly manufactured into salable articles. But the banker had a prejudice against advertising which nothing could shake. It is characteristic of the banker's work that it has a tendency to make him a slave to routine and to fixed ideas, which are obstacles to the prosperity both of his customers and of himself. CHAPTER XXIX NET INCOME sjtnoofll atBiotpoJ ssii gniiBlUDlBJ -vO # 305. A Condensed Income Statement The determination of income may be regarded as primarily a problem of accounting, but it is also a financial problem. We shall therefore take up for brief review the question of how corporate income is and should be determined. For purposes of illustration the following typical statement of income is reproduced from the December 31, 1921, report of the Consolidation Coal Company. Earnings from Operations $25,179,374.42 Operating Expenses, Taxes, Insur- ance and Royalties, exclusive of Income and Excess Profits Tax. . $20,095,303.04 Depreciation 1,258,761.66 Depletion 1,003,262.17 22,357,326.87 Net Earnings from Operations $ 2,822,020.55 Profit from sale of Capital Assets 194,119.18 Income from Other Sources 1,055,273.09 $4,071,412.82 Interest 1,332,819.27 Net Earnings for the year, before deducting Income and Excess Profits Tax $2,738,593-55 Less: Reserve for Income and Excess Profits Tax 500,000.00 Surplus for the year $2,238,593.55 Realization of Appreciation of Coal Lands, March i, 1913 917,892.10 Surplus for the year available for Dividends $3,156,485.65 Less: Cash Dividends declared for the year 1921 2,411,980.50 Net surplus for the year carried to Profit and Loss $ 744,55- I 5 867 868 CORPORATE FINANCE [Bk. II- Ignoring the appreciation in value of coal lands, this state- ment shows, after payment of dividends, a deficit of operations for the year of over $173,0x50. The year 1921, however, shewed many deficits from operation, and as the present company has a surplus exceeding $90,000,000 the matter is not one to cause alarm. 306. Calculating the Corporate Income The above example of an income statement shows the essen- tial steps in calculating income, which are as follows : 1. State gross earnings. 2. Deduct operating or manufacturing expenses, including selling, administrative, maintenance, depreciation, de- pletion, etc. 3. The result is net earnings from operation. 4. Add income from other sources. 5. The result is total net income. 6. Deduct taxes, interest, rentals, sinking fund and any other fixed charges. 7. The result is surplus for the year applicable to dividends. 8. Deduct preferred dividends. 9. Deduct common dividends. 10. The result is surplus or deficit from the year's opera- tions to be credited or debited to surplus account. 307. What Constitutes Income It seems hardly worth while to point out that income and expenditure are by no means identical with cash receipts and cash disbursements, though this elementary distinction is not always grasped. Income as understood in modern business in- cludes all the various kinds of realized gain from operations during a given period. This gain may be realized in the form of increased accounts receivable, enlarged facilities for production, reduced obligations, or in various other ways. Inasmuch as the extent of the gain is frequently difficult to measure, there is con- Ch. 29] NET INCOME 869 siderable latitude for the exercise of discretion and good faith on the part of officials in estimating income. It is therefore possible for them, if they are not governed by the strictest integrity, to enlarge or reduce the statement of income which they give to their stockholders and to the public to such an extent that these statements become dangerously unreliable. 308. Gross Earnings Appreciation in Value Under such conditions the greatest conservatism and honesty should obtain all through a financial statement. If it does not, the statement is not only a fictitious presentation in itself, but is an absolutely unsafe basis for future action. A typical lack of conservatism in the matter of earnings is found in the early history of the United States Realty and Con- struction Company. In its first report, earnings for the first nine months of the company's existence were given as $1,417,000; but it later appeared that $487,000 of these earnings consisted of "profits from estimated increase in the value of investments still held." This item is characteristic of a procedure frequently advocated by corporate officials who desire to make a showing of profits that have not been earned through operation. Real estate, securities, stocks of merchandise, and the like are con- stantly fluctuating in value. If any of these properties are actually sold and a profit is realized, it is entirely proper that this profit should be credited to surplus, but to credit it to the surplus arising out of operations during a given period is to give a dis- torted view of the operations for that period. Beyond this, so long as the profit is not realized, but exists simply on paper, it is a rule of accounting practice that it should not be credited at all. Officers who advocate marking up profits on account of fluctua- tions in value of permanent holdings are frequently the first ones to find some plausible reason for declining to mark down profits when these same holdings decline in value. If a company is engaged in the business of buying and selling real estate or securities, the case may be different and may be wo.'thy of further 870 CORPORATE FINANCE [Bk. II- consideration, but in other cases such profits should not be credited unless realized. 309. Cost or Market as a Basis of Valuation Before the Great War, the accounting rule that valuations should be u at cost or market, whichever is lower," was almost invariably adhered to in conservative practice. The wide variations of costs and values resulting from war and postwar conditions have, however, brought about some' changes in the application of this rule, and the general principle that incre- ments in values of assets should not be brought on the books until the profit has been actually realized by the sale of the assets has been liberalized. For instance, in 1920 the Consolidation Coal Company by revaluations of its coal lands brought into its income statement and added to surplus an amount of over $33,000,000.! In the 1921 income statement of this company shown earlier in the chapter, a similar addition to surplus is shown of almost a million dollars. The following opinion on this subject is interesting : 2 My suggestion is that when reappraisals or inventories at market indicate higher values than cost, the appreciation may be expressed in the balance sheet provided the increment is not set up as realized. I am not sanctioning the practice of anticipating profits, for that is vicious. Let me illustrate. If a concern buys or produces copper at 10 cents a pound, which at the date of inventory is freely selling at 15 cents a pound, and the market continues to rise after thedateof the balance sheet, surely no sound accounting or economic principle is being violated if the market value as well as cost is shown in the balance sheet. To carry copper at 10 cents because cost is lower than market, would be positively misleading unless the additional financial resources of the concern are dis- closed somewhere on the statement. Likewise, when copper costs 20 cents and at the date of balance sheet is selling for 18 cents, and after the date of the balance sheet has declined still further, it is equally deceptive to value the copper at 18 cents merely because that happened to be the market price on one day. i See Book III, 5 26, 27. '' Montgomery's Auditing, Vol. I, p. 5. Ch. 29] NET INCOME 871 310. Gross Earnings Profits on Work in Progress Another doubtful item from the standpoint of conservative practice is found in the first report of the United States Realty and Construction Company referred to in the preceding section. It includes among the earnings of the period the sum of $577,000, for "profit on buildings in progress, estimated proportion accrued." Here, however, there is more room for debate It would seem unfair that companies which customarily engage in long-time contracts, such as the construction of buildings and the like, should credit no profits to the period in which the con- struction work is going on. On the other hand, it was found in the case of the United States Shipbuilding Company that the anticipated profits on large contracts, which had been counted in the millions of dollars, were never realized, but actually turned into a loss at the completion of the contracts. Estimates of profits on uncompleted contracts are likely to be made by officers whose judgment may be warped by their own interests. Such items are to be considered, therefore, with some degree of skep- ticism. Another fruitful source of error in stating gross earnings is over-optimism in the valuation of finished and partly finished products and raw materials on hand. Sometimes balance sheets are found in which inventories amount to several times the aggregate of gross sales. In such cases it is clear that even a slight excess valuation of the inventories may be the real source of a considerable proportion of the alleged profits. Where the item of inventories appears to be constantly growing, from year to year, more rapidly than sales and profits, the estimate of gross earnings should certainly be subjected to close examination. Particularly is this true in a period of deflating values such as existed in 1920 and 1921, when many inventories were reduced one-half or more by falling values. It should never be forgotten that, by reason of the discretion which is necessarily accorded to them in estimating gross earn- ings, corporate officials ought to be exceptionally cautious, and 872 CORPORATE FINANCE [Bk. II- for their own protection should rely to a great extent upon the judgment of impartial accountants and other outside advisers. Misstatements of gross earnings are not made necessarily with dishonest intentions; the men who are most interested in the business are frequently the very ones who are most easily per- suaded that an exaggerated estimate of unrealized earnings is sound and reliable. 311. Operating Expenses and Reductions There is usually little question as to the actual outgo for raw materials or other purchases, labor, selling expenses, salaries of . officers and other administrative overhead, etc., all of which are directly chargeable to the various accounts that are grouped under the general heading of "Operating Expenses." Even here, claims are sometimes advanced in favor of charging such expenditures as those for advertising and for training employees, to capital accounts rather than to operating expenses, on the theory that such expenditures are a permanent benefit to the business. If such claims are to be allowed at all, which is usually doubtful, it is regarded as correct practice to charge them to some such account as "Deferred Expenses," which is carried on the balance sheet for the time being as a capital account but is intended to be written off within a brief period. There is little, if any, question also as to most expenditures for repair and maintenance of the permanent property of the business. This property must be kept up as nearly as possible to its original standard of efficiency, and the expense of so doing can scarcely be regarded otherwise than as a portion of the total expense of operation. Going a step farther, it is well to point out that many new companies make a serious error in not beginning at once to charge against profits a fair allowance which will take care of a portion at least of the repairs and other maintenance expenses that are to be expected in the course of a few years. Owners of apartment houses and other city real estate are fre- quently negligent in this respect. A building of this character Ch. 29] NET INCOME 873 may run for some years with comparatively slight outlay for repairs; then all at once everything is out of order. Either large sums must be expended and charged against operating expenses, or the character of the building will change for the worse and a lower income will be obtained. The same line of reasoning applies to many manufacturing establishments. 312. Reserves Nearly all well-managed corporations charge against the profits of each year an estimated sum, or a number of distinct estimated sums, which are intended to provide for losses and expenses likely to arise in the future but which are incident to the operations of the current period. The sums so charged are credited to reserve accounts, which are carried on the balance sheet of the company. As to the nature and use of these reserve accounts, there is much misunderstanding. They do not consist, as people seem sometimes to imagine, of funds of cash or property set aside for the purpose of meeting future expenses. It is, in fact, easily possible that a company may accumulate large reserve accounts and yet be quite unable to meet the anticipated expenses when they actually arise. This is due to the fact that the reserved profits are tied up in stock or equipment or in other ways and the company is short on cash and free credit. The essential character of all such reserves lies in the fact that they constitute a deduction from profits. They exist only in the form of entries and figures in the company's books of account. It is quite possible that a firm which carries no reserves on its balance sheet may be just as conservatively managed as the one which has large reserves. But the proba- bilities are the other way, for the reason that proper estimates in favor of reserve accounts assist the officers and stockholders of a company in gauging the true status of the business and tend to prevent over-optimism and dividends that should not be paid. 3 See Book III, Ch. Ill, "Reserve Accounts." 874 CORPORATE FINANCE [Bk. II- 313. Depreciation The most common form of reserve is that for depreciation in the value of fixed assets, due to wear and tear, obsolescence, etc. Depreciation on account of wear and tear may be estimated in advance with some accuracy, but depreciation for obsolescence is always of uncertain amount. No one can foresee what changes in taste or fashion, what unthought-of inventions, or what im- provements in organization may take place, which will perhaps render useless, or partly useless, much of the company's plant, machinery, or other assets. The best that can be done is to make a fairly liberal estimate, based on the experience of the past and trust that it will be sufficient to keep the book value of fixed assets always well within the limits of actual value. If this result is not accomplished, then the depreciation reserve is in- sufficient and net income is overstated. 314. Fallacious Depreciation Offsets Although the presence of depreciation as an actual factor in every business can scarcely be denied, yet the absence of any depreciation charges and reserve accounts on the books of cer- tain corporations is defended by fallacious arguments. For example, many street railway companies and other public utility corporations decline to make any deduction for depreciation charges from gross income. The claim which many of them advance is that the value of their franchises is constantly in- creasing and is sufficient to offset the admitted decline in value of their road-bed and equipment. Much the same argument is advanced by some of the large oil companies which claim that appreciation in the values of some of their properties is a proper offset against the depletion of others. This kind of argument is apparently advanced simply to justify a line of action previously determined upon. It is based on a twofold fallacy. First of all, granting that there is a steady rise in the value of franchises or a marked increase in the value of certain oil land, and that this increment should be taken Ch. 29] NET INCOME 875 into the income account, it should be then valued by itself and shown as a source of income, while depreciation or depletion charges should be shown as a deduction from income; otherwise there is not even an attempt to make up a fair and reliable income statement. In the second place, in the case of the street railway, experience has shown that the alleged increase in the value of franchises is a highly uncertain factor. Most public utility enterprises are subject in a peculiar degree to legislative control and the legislature usually takes care that franchise values are not permitted to increase with excessive rapidity. Even if this were not the case the present-day swarm of jitneys and auto- buses can be depended upon to take care of the matter. 315. Insufficient Depreciation Another fallacy is clearly shown in a report of the Canadian Locomotive Company, which includes this remarkable assertion : "We have not added anything to depreciation reserve account as we feel that, our plant being new, the $75,000 already at the credit of this account is sufficient." Following out this line of reasoning, it is evident that depre- ciation reserves are to be set aside only when the period has arrived in which they are actually needed. This makes the so- called depreciation reserve and the account for repairs and maintenance, practically identical, and does away with the only genuine reason for the creation of a depreciation reserve. Com- panies that have new plants and are enjoying prosperity are the very ones which should be setting aside liberal reserves for de- preciation. In contrast to this position is the action of the Baldwin Locomotive Works which wrote off from surplus the entire cost of the munition plants constructed by it at the time of the Great War. It is particularly necessary to set aside liberal reserves and write down severely in time of inflation. The London Economist has put the truth of the situation clearly in the following words: "Depreciation allowances are all the more necessary in a boom 876 CORPORATE FINANCE [Bk. II- period, because there is always the practical certainty that the boom will decline more or less suddenly and will leave over- valued stock on hand." Many companies of high standing are at the present time embarrassed and in some cases on the verge of bankruptcy because sufficient reserves were not set aside during the inflated period that came with the Great War. 316. Arbitrary Depreciation Allowances The practice sometimes followed of arbitrarily setting aside for depreciation such sums as can conveniently be spared out of the annual surplus regardless of the amount actually required, is not one to be encouraged. This practice is followed, it is true, by some of the greatest and best-managed concerns of the country. But it is essentially unsound. Depreciation is not a theory or a vague notion in someone's head ; it is an actual ele- ment in the operation of every business; it is going on night and day, through all seasons, year after year, in periods of depression as well as in periods of prosperity. The provision against de- preciation should constitute, therefore, a regular charge against gross income. The amount of that charge should be estimated as accurately as possible and should be adhered to year after year; otherwise we get a purely fictitious showing of net profits. If large sums are charged off in one year and nothing is charged off the next year, the final showing of profits in the two years may be about uniform, whereas the business has perhaps really suffered an enormous fluctuation. The purpose of accounting should be, not to conceal such facts, but faithfully and clearly to set them forth. 317. Depreciation of Intangible Assets Depreciation of intangible assets should be liberally estimated and provided for. In fact, it is generally agreed that intangible assets should be written off at an especially rapid rate, even though their real value may not be decreasing. Many bankers and other financial men have a very high regard for what is Ch. 29] NET INCOME 877 called a "clean" balance sheet, that is to say, one which includes only tangible assets at a conservative value with ample reserves to cover all possible losses. This preference seems to be in many cases little more than a prejudice, inasmuch as such assets as patents, copyrights, good-will, and the like may be permanent and constitute the greatest value of a valuable business. Under such conditions they may properly be carried as real assets. Nevertheless, even where this is the case, it is often advisable to defer to prejudice that has been created through the unscrupu- lous and reckless valuation sometimes placed on intangible assets, and to carry out the policy of "writing off" with consid- erable rigor. 4 318. General Reserves There are many other kinds of reserves which should be carried if the business of a company is to be based on sound accounting and finance. The business of many companies, for example, requires them to enter into contracts which involve immediate payment on the part of the purchaser of their prod- ucts, combined with a liability assumed by the company to render future service. A company publishing a magazine usually collects subscription payments in advance and contracts to deliver the magazine over a twelve months' period. This being the case, it is clear that the company actually earns the subscription payment only as it proceeds through the year with the delivery of its magazine, and that it would be improper to credit the subscription payment as income of the week or month in which it is received. The modern custom among magazine publishers is to credit an account called "Unearned Subscrip-. tions" for payments sent in by subscribers, and at the close of each month to debit this account and credit another account called "Subscriptions Earned," or some similar title, for tlie proportion actually earned by sending out magazines during that month. 4 See Book III, 58 144-146. 878 CORPORATE FINANCE [Bk. II- Any future outgo on contracts that are taken into current income account should be watched and provided for with the greatest care. Companies that are conservatively managed will always provide for future or contingent expenses of this kind. In the 1920 balance sheet of Babcock and Wilcox, for example, one item consists of "Reserve for completion of contracts, $2,316.038." Another instance of commendable conservatism is given in the following quotation from the 1921 report of the president of the International Harvester Company: In the early years of the war, the officers and directors realized that the advance in prices of raw materials would affect this in- dustry in a peculiar way. It was evident that if the inventory were valued according to high war-time prices, the profits would be materially increased, and when, after the war, the inevitable decline in prices occurred, the company would be confronted with large losses due to such declines. The company is compelled to have on hand constantly an inventory of raw materials, work in process, and finished machines of at least 50% of the gross sales of a normal year. The turnover in this business, that is, the period between the purchase of raw materials and the sale of the manufactured product, averages about twelve months, whereas in some lines of production the turnover is made in a much shorter time. In view of these facts it was decided that so much of the inven- tory as represented the portion constantly on hand (termed the basic inventory) should 'be valued at prewar (1916) prices and carried on the balance sheet at those prices; and that fluctuations in values should be reflected only in the amount of the inventory carried in excess of the base inventory. This policy was adhered to even though the United States government for taxation purposes valued the entire inventory at cost or market prices, thus resulting in the payment of taxes on profits never realized. The inventory at the close of 1920 was valued at the then cost or market, whichever was lower, and is so valued in this balance sheet. The company shows a net profit for the year 1921, not- withstanding the decline in value of the inventory. Had not the company adopted conservative methods in valuing inventories during the past few years the balance sheet for 1921 would have shown a net loss in excess of $20,000,000. Ch. 29] NET INCOME 879 Another instance of cautious financing is explained in a letter from President Mitchell of the National City Bank to its stockholders. This letter referring to the 1921 operations says: During the past year, in addition to writing off from undivided) profits the good-will cost represented in the acquisition of the Second National Bank, the Commercial Exchange Bank, and the Paris branch of the Farmers Loan & Trust Co., we have, from time to time, charged current earnings and undivided profits, crediting reserves and allocating to specific accounts sums which cover, with the exception noted below, every probable loss disclosed by careful analysis of the accounts of our head office and all of our branches. The exception is some probable loss in a group of loans to sugar estates in Cuba and a single loan in South America, the liquidation of which will in some degree depend on future trade conditions. These accounts have been the subject of special study by the management and by committees of our board of directors, and plans have been laid for working them out as rapidly as possible. We anticipate that the ultimate loss on these items will not be serious. In order, however, to amply provide for such shrinkage as may occur in these accounts, and to take up any other possible losses that careful scrutiny has not at this time revealed, the board of directors has deemed it conservative to establish a reserve for contingencies in the amount of $10,000,000 by a direct charge to undivided profits in that amount. Further, the board has ap- proved a policy of maintaining this reserve for contingencies at all times at not less than $5,000,000. 319. Concealment of Profits We have spoken above of charges for repairs, renewals, main- tenance, and depreciation as being properly included in operating expenses or in deductions from gross income, and have empha- sized the necessity for liberal allowances. There is, however, a possible, although not so frequent danger of going to the opposite extreme. Depreciation charges may be too high, and thus the showing of earnings may be unduly depressed. Again the various accounts included under the general headings of "Repairs," "Renewals," and "Maintenance" may be stretched so as to include outlays for betterments. In this 88o CORPORATE FINANCE [Bk. II- case earnings on the income statement are decreased and the capital assets are at the same time built up but without any corresponding increase in their valuation on the balance sheet. Something of this kind has happened frequently in the manage- ment of railroad companies in the United States. Conservative companies will include in their "Maintenance" accounts, ex- penditures for reballasting, for laying heavier rails, for putting in permanent culverts and even bridges and for purchasing new locomotives and cars. After this practice has been carried on over a period of years and the property has been put into excel- lent condition, the profits are no longer diverted into and appar- ently lost in capital expenditures, the statements of earnings are allowed to expand to their correct proportion, and the stockhold- ers of the second period are perhaps given enlarged dividends or a "melon" of some kind. A notable instance of this procedure was afforded by the Lehigh Valley Railroad Company under the management of President Walter from 1898 to 1904. During these six years the stockholders noted in each year's accounts that the charges for maintenance, repairs, etc., were reaching unprecedented heights and that the net profits were correspondingly reduced. They suspected the truth that expenditures for betterments were being charged into maintenance accounts and many of them protested, but without effect. 320. Is Concealment of Betterment Expenditures Justifiable? The management in the Lehigh Valley case, as in many other similar cases, took the attitude that they were the ones best acquainted with the needs of the corporation and were better entitled than were the stockholders to judge as to the necessity for betterment expenditures. They took, therefore, the course which seemed to them proper, and in order to avoid objection and interference, concealed or partially concealed the ex- penditures for betterments, thus improving the property of the corporation without the stockholders' knowledge or consent. Ch. 29] NET INCOME 881 The motives of the management in this case were unim- peachable, and there can be no doubt, as we look back, that the Lehigh Valley and its stockholders as a body have been greatly benefited by the policy that was followed. And other corpora- tions have done the same thing with advantage to their stock- holders. The question is, however, not whether accumulation of surplus out of earnings is wise, but whether concealment of the accumulating surplus is right. Concealment makes it easier for the directors to reserve profits. But it also offers a wide opportunity for fraud. And, speaking generally, the owners of property have a right to know its true status. Therefore, while recognizing the force of the arguments in favor of secrecy when a diversion or accumulation of surplus or profits is under way, the reply to the question must be in the negative. 321. Two Classes of Betterments Before leaving this subject, it may be well to call attention to the two different classes of betterment expenses which are gen- erally regarded as being properly financed in two different ways. One class consists of betterments which are certain to yield a definite, traceable return, either in the form of enlarged revenue or in the form of savings in outgo, as, in a factory, a better engine that will develop more power from the same amount of fuel. The second class of betterments consists of those which are considered desirable and well worth the expense involved, but which will not yield direct and traceable profits, as in the same factory, a reading-room, or lunchroom for the employees. By general consent among the officers and directors of great corporations, it is agreed that the first class of betterments may properly be financed by the issuance of fresh securities, if it can clearly be shown that the interest or dividends on these securities will be provided out of the enlarged income or the savings made possible by the betterment. The second class of betterments, however, should be provided for out of surplus. They may prove to be highly profitable, but there is no certainty on that 882 CORPORATE FINANCE [Bk. II- point. The only money that should be spent on them, there- fore, should be money that has been accumulated out of the profits of the preceding years or that is currently accumulating. In case the judgment of the directors should be wrong, and the betterments should not make for enlarged profits, the corporation would at least escape a loss that would be damaging to its credit. The Pennsylvania Railroad Company has, perhaps, been the most consistent follower of the principle that has just been presented. In financing $150,000,000 of improvements of the company in New York City terminals, including tunnels under the North and East rivers and the magnificent terminal building, approximately one-half the investment was provided by fresh issues of securities; the other half was provided by charges against the surplus of ' the Pennsylvania Railroad and allied companies. CHAPTER XXX DIVIDENDS i 322. Fixed Charges After a corporation's net income has been determined, it is in order for the directors to consider how it shall be distributed. Normally net income is distributed through three channels: fixed charges, dividends, and additions to surplus. As to "Fixed Charges" there is little that needs to be said at this point. They consist of taxes, payments on leases and rentals, and interest payments on the funded obligations. The amount of fixed charges (except for taxes) is determined by the amount and form of the company's capitalization and of its long- term contracts. At the time when net income for a given period has been determined and its distribution is under advisement, the payments for fixed charges are no longer questions within the discretion of the directors or of anyone else connected with the company. Unless they are paid as they become due, the company ceases to be solvent. Such charges might, of course, and frequently have been in the past year, paid from surplus, but for the present purposes we will assume that net income is more than sufficient to meet fixed charges, and that there is remaining a balance available for dividends and surplus. 323. Dividends and Surplus As to the distribution of the available balance of net income between dividends and surplus, the board of directors is the sole authority. Neither officers nor stockholders, as such, have any voice in the matter and there are few effective legal restrictions. i See also Book I, Chs. LII, LIII "Dividends"; also Book III, Ch. XIV, "Dividends." 883 884 CORPORATE FINANCE [Bk. II- We have before us, then, for treatment in this and in the following chapters, the two closely related questions: What principles should guide the directors in fixing divi- dends? What principles should guide the directors in accumulating and in using surplus? 324. Classification of Dividends Two classes of dividends are to be considered: those which are preferred and cumulative (with which may be included the so-called interest on income bonds), and those which are common or ordinary and have no special priorities. As to preferred dividends, much the same reasoning applies as has just been stated with regard to fixed charges. There is left, to be sure, a much larger measure of discretion to the direc- tors, who may, at their option, decide to defer the payment. But there is a corresponding penalty in the fact that the accumulated dividends constitute a growing barrier in the way of common dividends, and that the credit of a corporation is adversely affected by piling up large arrears of preferred divi- dends. For these reasons corporations that are earning sufficient profits and are in strong enough financial condition, usually pay their preferred dividends without much argument. There are, to be sure, some exceptions, but the pressure in favor of payment of preferred dividends, when possible, is effective in the great majority of cases. Preferred dividends which are not cumulative belong in a different class. The interests of the common stockholders, whom the directors usually represent, require that non-cumula- tive preferred dividends be passed until common dividends can also be paid. Hence we may include all dividend charges which have priority, but are not cumulative, under our consideration of common or ordinary dividends. 2 'For detailed discussion of cumulative and non-cumulative dividends, see 3 60-62; also Book I, (} 109, no. Ch. 30] DIVIDENDS 325. Average Rates of Dividends A valuable compilation showing the amount of railway stock in the United States which pays dividends, the percentage of this dividend-paying stock to all outstanding railway stock, and the average dividends over a period of years, is reprinted below. 3 Year Ended Amount of Stock Yielding Dividends Per Cent of Stock Yielding Dividends Amount of Dividends Declared Average Rate on Dividend Yielding Stock June 30, 1908 $4,843,370,740 65.69 $390,695,351 8.07 1909 4,920,174,118 64.01 321,071,626 6-53 1910 5,412,578,457 66.71 405,77i,4i6 7-50 1911 5,730,250,326 67.65 460,195,376 8.03 1912 5,581,289,249 64-73 400,315,313 7.17 1913 5,730,982,416 66.14 369,077,546 6-37 1914 5,667,072,956 64-39 451,653,346 7-97 1915 5,219,846,562 60.45 328,477,938 6.29 1916 5,279,427,954 60.38 342,109.396 6.48 Dec. 31, 1916 5,430,123,235 62 O2 366,561,494 6-75 1917 5,610,774,033 62.32 381,851,548 6.81 1918 5,138,851,230 58.09 339,185,658 6.60 1919 5,298,320,617 S9-64 335,241,935 6-33 1920 5,056,814,549 57-24 328,989,492 6.51 It is of especial interest to note that over one-half of the railway stock outstanding in the United States during recent years has been paying dividends. Some interesting figures as to the invested capital of the cor- porations of the country and the dividends paid thereon are contained in the 1922 "Statistics of Income" issued by the Treasury Department. For the year 1919, according to these statistics, 102,037 corporations reported the amount of their invested capital. The grand total was $66,130,351,148. The net income of these same corporations for 1919 before payment of taxes was $9,305,769,954. Income and excess profits taxes amounted to $2,162,260,244, leaving net income available for dividends of $7,143,509,710. 1 By courtesy of the Bureau of Railway Economics. 886 CORPORATE FINANCE [Bk. II- The statistics do not give directly the amount paid out by these corporations in dividends, but the individual returns for the same year show total receipts from dividends of $2,453,774,- 825. Ignoring dividends received by corporations holding securities of other companies, which it is presumable would eventually come into the hands of the individuals, this gives us a rough basis for calculation, and from this we find that the per- centage of net income to invested capital is approximately 10.96%, and that the dividends actually paid were approximately 3.767% on the total corporate capital. 326. Percentages of Earnings Devoted to Dividends An instructive tabulation of the income statements of about 900 English companies for the year ended July 31, 1914, before the economic conditions of the country had been disturbed by the Great War, shows the following distribution of profits : Net Profits Preferred Dividend Ordinary Dividend Surplus, Reserves, etc. % % % Breweries 2,400.7^0 486,255 20. 2 1,312,820 C4.4 610,684 2^.4 Gas 8^6,^41 1^0,720 l6. 332. Dividend Practice Regular Dividends Taking a few examples first .of regularity of dividends, we have such records as that of the American Sugar Refining Company, which paid regular dividends every year from 1901 to July 1921 of 7% per annum, and an extra dividend of %% each quarter from July 2, 1918, to October 2, 1920. The Mergen thaler Linotype Company, during the ten years 1902 to 1912, paid 10% regular dividends plus a 5% extra dividend each year, making 15% annually. Since then its dividends have ranged between 10% and 15%. The dividend record of the John B. Stetson Company, which follows, is an excellent example of stability combined with liberal distribution of large profits accumulated during the earlier years of the company's existence. It will be noted that after 1893 dividends were decreased slightly, but this is to be explained by reason of the great depression which existed from 1893 to 1896 and which could not reasonably have been foreseen: JOHN B. STETSON Co. COMMON DIVIDEND RECORD 1892-1893 6% (per annum) 1905-1907 20% and 5% extra 1894-1896 4% (per annum) (per annum) 1897 5% 1908 25% " 25% " 1898 8% 1909 25% 1899 12% 1910 25% " 25% " 1900 15% 1911 25% 1901-1902 17% (per annum) 1912 25% " 25% " 1903-1904 20% (per annum) 1913-1920 25% (per annum) The dividend record on the common stock of the National Ch. 30] DIVIDENDS 895 Biscuit Company is an excellent example of conservative and well-sustained dividends. It is as follows: 1899 i 1909 1900-1905 4% (per annum) 1910 6% 1906 ' 5% iQ" 8 ^% 1907 SK% 1912-1921 7% (per annum) 1908 6% An even better record is that of the Delaware and Hudson Company which since 1897 has paid dividends as follows: 1897-1900 5% (per annum) 1901-1906 7% (per annum) 1907-1921 9% (per annum) The Eastman Kodak Company has paid regular 10% dividends since 1902, but with extra dividends in most years running from as low as 9J/% to as high as 50%. These extra dividends are so high that they overshadow the regular dividends, and if any criticism of so successful an enterprise is permissible, it may be based on the desirability of attaining a greater degree of regularity in the extra as well as in the so-called "regular" disbursements. 333- Dividend Practice Irregular Dividends On the other hand, concerns engaged in fluctuating lines of business, frequently decline to restrict themselves to the pay- ment of a fixed dividend rate. The dividends of the Anaconda Copper Company ranged from 3% in 1913, to 26% in 1907, and then down until they were suspended entirely in 1920. There is less excuse for such fluctuations in the case of the American Thread Company, the business of which is relatively stable; nevertheless from 1902 to 1921 dividends varied from as low as 4% to as high as 18%. The Bourne Mills, manufacturing textiles, paid dividends between 1897 and 1921, fluctuating from as low as 3%, to as high as 49^%, this "peak" dividend being followed in the next year by a dividend of 896 CORPORATE FINANCE [Bk. II- Following is the record of the Porto Rican American Tobacco Company, which is even more remarkable for the extent and rapidity of its fluctuations: 1904 8% 1913 20% (scrip) 1905 3i>^% i9 J 4 20% (scrip) 1906 84% 1915 4% and 5% (scrip) 1907 10^2% 1916 4% and 10% (stock) 1908 5% 1917 4% and 8% (scrip) 1909 9% 1918 9% (scrip), 4% (stock) 1910 14% 1919 6% (scrip) 1911 16% 1920 12% (scrip) 1912 16% and 20% (scrip) 1921 3% (scrip) The Atlantic Refining Company, like various companies of the oil and other extractive industries, prefers to allow its dividends to fluctuate with its profits. Before the disintegration of the Standard Oil Company it was customary for the directors to determine at the end of each quarter what rate of dividend for the quarter should be declared. In this case the fact that the company, although of enormous size, was comparatively closely held, was no doubt another reason for the practice of letting dividends follow profits. From companies engaged in extractive industries come the most remarkable records of enormous profits, and it is perhaps natural that the desirability of stability in their dividend dis- bursements should not appeal to them as of great importance. The Calumet and Hecla Mining Company, which has out- standing about $2,500,000 of capital stock with a par value of' $25, of which only $12 per share is paid up, has paid out total dividends from 1871 to July i, 1920, amounting to over $150,000,000. The Koloniale Bergbau Gesellschaft (Colonial Mining Company), a German concern, which operated dia- mond mines in German Southwest Africa, used to be one of the large dividend payers. Its capital was only about $25,000. Ch. 30] DIVIDENDS 897 Its dividend record up to the year of the Great War was as follows : 1910 2,400% 19" 2,500% 1912 3.800% 2,500% Total for four years 11,200% It is stated by financial writers that in the period of deflation existing in 1920-1921, over 100 prominent companies, the majority of which had stock listed on the New York Stock Exchange, either passed or curtailed dividends. The great advantage of prudent management in the main- tenance of a comparatively low but regular rate of dividends is shown in the record of two great railroad companies. In 1913 the earnings of the Pennsylvania Railroad Company fell to the lowest figures except one in fifteen years, and in 1914 there was a further sharp decline. Nevertheless, even at this level the company's regular 6% dividends continued unaffected until the abnormal conditions of 1920 and 1921 forced them down to 4% in the latter year. Good as this is, the record of the Dela- ware and Hudson Company, given on a preceding page, is better, for its dividend has been maintained steadily at 9% through all the trying period from 1914 to date. CHAPTER XXXI PAYMENT OF DIVIDENDS 334. Dividends from Accumulated Surplus Frequently it is a question, when the net income for a given period is not sufficient to pay dividends, whether these dividends should nevertheless be paid and charged against the surplus that has been accumulated in previous periods. Ordinarily the answer that should immediately be given is, no. It is equivalent to an individual drawing unnecessarily upon his savings, and while conditions may exist which justify such a depletion of reserves, it should not ordinarily be permitted. All this refers to customary financial practice, and not to the legal view of surplus which makes no distinction between that which has been accumulated in the past and that which is current. The legality of paying dividends out of accumu- lated surplus cannot be questioned. 1 The company may if it will, and the only question is as to the wisdom of so doing. Granting, then, that accumulated surplus is legally available for the payment of dividends, when will good practice permit its use for this purpose? In July, 1914, the directors of the Baltimore and Ohio Railroad Company voted the usual semi- annual dividend of 2% on the preferred and 3% on the common. The required total of dividends for the year, which amounted to $11,538,888, was greater than the surplus during the year by $2,469,095. It was explained unofficially that the company had not exercised its privilege of prorating depreciation charges over a series of years, but had charged against current earnings over $2,000,000 of losses incurred in the Central Western floods of 1 As to this and the legal phase of dividends generally, see Book I, Chs. LIT, LIU; for accounting treatment of dividends, see Book III, Ch. XIV. 898 Ch. 31] PAYMENT OF DIVIDENDS 899 March, 1913. The action of the directors was based on the belief that the decline in earnings was only temporary, and on a pro- found desire to maintain an unblemished record of regular dividends. There is no question as to the conservatism and ability of the board and this action was somewhat grudgingly accepted by the financial community as sound and correct. In 1921 the Louisville and Nashville Railroad Company drew heavily on surplus for dividends, its income statement for the year showing a deficit of over $5,000,000. This followed a profit after payment of dividends in the preceding year of over $2,700,000. As the road has undivided profits of over $70,000,000, it could well afford to draw on these to keep up the regularity of its 7% dividend. The objections to paying dividends out of surplus under nor- mal conditions are obvious. Not only is it ordinarily an im- proper use of surplus a squandering of permanent reserves but it is a public exhibition of bad management and an advertise- ment of the fact that the company is not making adequate profits. 335 Cash Requirements for Dividends In discussing the payment of dividends so far, it has been as- sumed that adequate and regular profits provided they are correctly estimated justify dividends. But this assumption cannot be permitted to stand unchallenged. It is, in fact, the direct source of a large proportion of financial embarrassments. Profits do not necessarily mean cash on hand, and thousands of corporations which have been able to report highly satisfactory profits and which have paid good dividends on the strength of those profits, have found themselves a short time later to the intense surprise and indignation of their stockholders and even of their directors and officers in the hands of their creditors. It is quite apparent that many business men, even including some of unusual capabilities, do not fully grasp the fact that dividend payments should be dependent not only upon profits, but also upon the corporation's cash position. 900 CORPORATE FINANCE [Bk. II- The point has already been emphasized and will later be reiterated, that many companies find their chief financial diffi- culties arising, not in periods of depression and small business, but in their periods of prosperity. If more business is to be done more working capital is usually imperative. To attempt to do a large volume of business with a small working capital is one of the quickest and surest methods of financial suicide. Yet this is precisely the course that is followed by those concerns which, on the strength of a showing of profits, declare dividends, the payment of which seriously depletes their working capital. Under these conditions the only prudent course is to withhold dividends until in the normal course of the company's business cash is accumulated beyond the requirements of the business. It is not merely a book surplus, but, in addition, a satisfactory cash balance, that should furnish the basis for a declaration of cash dividends. To give a concrete illustration of a situation which does not justify cash dividends, we may take the case of a flour mill company operating in Canada which has outstanding capital stock of $i ,000,000. During a recent year the company reported net profits available for dividends amounting to $91,462, and declared dividends of $30,000, or 3%, leaving an addition to the surplus of $61,462. On the face of it there would seem to be no reasonable question as to the conservatism of this small dividend declaration. When we come to examine the company's balance sheet after payment of the dividend, however, we find that it shows a secured overdraft at its bank of $191,000. Its cash on hand is less than $6,000, and its cash and receivables together are less than its current liabilities. A glance at this balance sheet is enough to prove that the payment of dividends was not merely unwise, but a reckless and dangerous proceeding. 336. Paying Dividends with Borrowed Cash Sometimes circumstances arise which justify the directors of a corporation, in their opinion, in borrowing the money Ch. 31] PAYMENT OF DIVIDENDS goi with which- to pay dividends. This is, in fact, quite frequently the case with companies which have to contend with wide season- al fluctuations, and with companies which normally operate with a small working capital. As has previously been pointed out, transportation . and communication enterprises frequently be- long in this last-named group. Commenting on numerous cuts in the dividends of railway corporations, the London Financial Times of October 2, 1914, says editorially: It is necessary to be guided by the amount of cash actually in the till. Borrowing on temporary loans from one's bankers in order to make up the heavy amount of ready cash required to pay dividends a common and perfectly proper procedure in normal times is much less desirable under existing financial conditions. For companies of the two types just referred to, it may be sound policy at times to pay dividends with the proceeds of temporary bank loans assuming, of course, that there can be no reasonable question as to the company's ability to repay these loans without crippling itself. There is a great distinc- tion, however, between this situation and that which exists when a corporation issues long-term obligations or when it sells additional stock in order to obtain money with which to pay dividends. If a corporation were to follow this practice during a period when it was not actually making a legitimate showing of profits, it would be clearly engaged in a fraudulent transaction. When it issues long-term obligations or sells additional stock during a period of adequate profits or for the purpose of paying dividends that are charged against accumu- lated surplus, its course of action is not necessarily fraudulent, but it is certainly open to serious question as to soundness. A case which aroused a great deal of discussion in financial circles occurred in 1913, when the management of the American Can Company decided to pay up a portion of the dividend claims on its preferred stock issue which had been accumulating over a period of several years. The company sold an issue of $14,- 000,000 5% debenture bonds. Ostensibly the sale of the deben- Q02 CORPORATE FINANCE [Bk. II- tures was to recoup the treasury of the company -for capital expenditures from earnings and to provide additional working capital. The proper entries were made on the books, of course, but the cash proceeds from the bonds paid a 24% dividend on preferred stock, and the company's working capital had no more available cash than before. While it would have been safer for the company to pay off the arrears of preferred dividends from profits as they were made, it must be admitted that, as a practical matter, the company was not injured by this somewhat doubtful financing. It has since then strengthened its financial position greatly and, though no dividends have been paid on its common stock, has fully maintained its dividend on the preferred and had built up its surplus, at the end of 1920, to over $20,000,000. It is indicative, however, of its cash needs and also o the difference between profits and cash, that with over $20,000,000 of surplus early in 1921, this same company was forced to issue $12,000,000 in short-term notes to secure funds with which to purchase tin plate and other necessary material. 337- Lack of Prudence in Paying Dividends It seems almost superfluous, after what has been said above> to cite examples of financial difficulties which are traceable to the payment of dividends which were not earned or which could not be met without reducing working capital below the limits of safety. The number of examples is practically infinite. Some of the most flagrant are furnished by the records of im- portant industrial combinations. And, as to this, we cannot do better than present the following abstract: 2 Nearly all the large industrial combinations have been guilty of distributing dividends recklessly. This is due in part to the extravagant promises on the strength of which securities have been sold, in part to the optimism of promoters and directors, in part to a desire to unload on the part of insiders. 2 Dewing on Corp. Prom. & Reorg., p. 549 el seq. Ch. 31] PAYMENT OF DIVIDENDS 903 The failures of the Corn Products Co., The American Malting Company, the U. S. Realty Co. and the New England Cotton Yarns Co. were the direct results of unwarranted payments of dividends. The U. S. Leather Co., the National Cordage Co., the National Salt Co., the Consolidated Cotton Duck Co., and the International Cotton Mills Corporation, were all seriously weak- ened by payment of dividends at the expense of their cash position. In the case of the American Malting Co., it was proved that the directors must have declared dividends without having before them any statements of earnings. This same thing probably is true also of other corporations. The great fluctuations in industrial earnings are the chief argu- ment against the use of bonds by industrials and in favor of con- servatism in paying dividends. In 1908 the Westinghouse Co. had gross sales of $20,000,000 and a deficit of $1,000,000; in 1909, gross sales of $30,000,000 and a net profit of $3,000,000. These fluctuations involve a strong tendency to borrow on short-term notes or even to use short-term notes as a means of raising money with which to pay dividends. There is sound reason for borrowing on short time in order to meet fixed charges inasmuch as the insolvency and reorganization of the company, even though it be only temporary, involves a severe blow to its credit and trade. For instance, after the panic of 1907, the General Electric Co. had a loss of 25% in its business and the Westinghouse Co. 37%. The explanation seems to be in the failure of the Westinghouse Co. The fact that insufficient working capital exists at the time of the insolvency of a company is not proof that this is the actual cause of insolvency. It is very often true that the lack of working capital is itself due to unwise payments on account of fixed charges and on account of dividends. The only possible reasons which can lead directors to pay out dividends in the face of falling earnings and increasing floating debt are: 1. Ignorance of corporation's true financial position. 2. A belief that later proves unfounded in the immediate return of prosperity. 3. A desire to give the corporation a higher standing among bankers and investors than its earnings warrant. 904 CORPORATE FINANCE [Bk. II- 338. Scrip Dividends Scrip dividends are those which are issued in the form of promises to pay on the part of the corporation. 3 These promises may or may not bear interest. They usually mature at some definite date, but may be purely indefinite I. O. U's, redeemable at the option of the corporation or redeemable within a certain limit of time. They are intended usually to meet the situation which has been briefly described above that of a corporation which has made a good showing of profits during a given period, but is not in sufficiently strong financial position to part with cash. Payment of dividends in scrip is sometimes voted in order to avoid spoiling a dividend record that would otherwise be un- broken, or as a temporary expedient to keep up dividends on preferred stock issues. After the Westinghouse reorganization in 1891, the first dividend of i-K% on the preferred stock was issued in scrip, so as not to reduce the working capital im- mediately. In the fall of 1914, the Cambria Steel Company desired to keep up its regular 5% dividends, but on account of war con- ditions inventories were larger than usual, and available cash resources were smaller than usual, and the directors did not think it wise to pay out in cash the $562,500 required. The difficulty was solved by issuing a scrip dividend bearing 5% interest. The same thing was done in 1915. Since then all this scrip has been paid. Sears, Roebuck and Company paid a 2% scrip dividend in the early part of 1921, but perceiving that the crisis before the company was more serious and of longer dura- tion than at first supposed, suspended common stock dividends thereafter. The Porto Rican Tobacco Company, as noted in the preceding chapter, has paid many of its dividends in scrip. The payment of accumulated dividends on preferred shares has been, in a number of cases, taken care of in this manner. The Trenton Potteries Company has outstanding $411,570 of 3 See also Book I, 492. Ch. 31] PAYMENT OF DIVIDENDS 905 "funding certificates" which were issued to stockholders who exchanged their 8% cumulative preferred for a new issue of 8% non-cumulative preferred. These stockholders received 44%, being the amount of their dividends in arrears, in the form of "funding certificates," bearing interest, if earned, at the rate of 4%. 339 Stock Dividends 4 A form of dividend payment which appears to be growing in popularity is the issuance of stock representing profits not otherwise distributed. Stock dividends are issued for any of three reasons: 1. In order to give to stockholders tangible evidence of the increasing value of their property. 2. In order to keep the market price of the stock at a point which will make it more readily salable. 3. In order to veil huge profits in prospect by making it possible to declare a small or moderate dividend on a large amount of stock instead of a very high divi- dend on a small amount of stock. These three motives are not always clearly distinguished; one of the three is usually predominant. It will be agreed by everyone that the payment of a stock dividend does not in itself add anything to the assets of the stockholders who receive the dividend. If the owner of one share of stock in a cor- poration with $100,000 stock outstanding, is given, we will say a 900% stock dividend, so that he becomes the owner of 10 shares in a $1,000,000 corporation, his real standing has not been changed in the slightest. He remains, just as he was at the beginning, the owner of 1/1,000 interest in the enterprise. His only real gain comes in the mental satisfaction that he receives if he continues to hold his stock indefinitely (and this is by no means a negligible factor), or in the easier marketability of his 4 See also i 133. and Book I, { 490. 006 CORPORATE FINANCE [Bk. II holdings if he wishes to sell them. Even the third motive does not affect the shareholder's income but merely the nominal rate of dividend on his holdings. A number of companies have adopted the practice of paying regular stock dividends in addition to cash dividends. Annual 4% stock dividends were paid by the Proctor and Gamble Company from 1913 to 1920. The American Light and Trac- tion Company has for a number of years declared dividends in cash and also in stock. The American Gas and Electric Com- pany has paid stock dividends in addition to its cash dividends since 1914. These amount to 4% per annum with an extra dividend of 27^% in 1919. It may be assumed that the practice in the case of public utility companies has in view the desirability of keeping down the rate of cash dividends to a moderate amount. Much the same plan has been followed by some of the English public utility companies. The oil companies frequently pay stock dividends. Sinclair Oil Corporation paid 4% in 1920 and the same dividend in 1921 in no-par-value stock; Middle States Oil Corporation paid 12% in stock dividends in 1918, 38% in 1919, and 70% in 1920, all in no-par-value stock. In 1920 the Continental Oil Company paid a stock dividend of 200%; International Petroleum, Ltd., paid 100%; and the Standard Oil Company of Indiana 150%. In 1921 the Standard Oil Company of Nebraska paid a stock dividend of 200%, 340. Stock Dividends to Represent Surplus Stock dividends which are intended to represent large ac- cumulations of surplus that could not be disbursed in cash are frequent. Some of those mentioned were of this nature. Among the automobile companies, the Packard Motor Company paid a 40% stock dividend in 1913, and in 1916 paid stock dividends aggregating 60%. The record among motor companies up to the present time is, however, held by the Chalmers Company, v r hich in 1910 paid a stock dividend of 900%, The subsequent Ch. 31] PAYMENT OF DIVIDENDS 907 history of the company does not indicate any justification for this increase of outstanding stock. The record of the Singer Sewing Machine Company shows various stock dividends of 100% to 200%. Other instances are the Pacific Mills, which increased its capital stock from $3,000,000 to $12,000,000 in 1912, and declared a 200% stock dividend, at the same time reducing the par value of its shares from $1,000 to $100, and again in 1917 increased its stock and paid stockholders a 25% stock dividend; the American Rolling Mills Company, which paid a stock dividend of 33 M% m I 97> and another stock dividend of 100% in 1909, and additional stock dividends thereafter aggregating to February i, 1920, over 68%; the George E. Keith Company, which in 1913 issued $4,000,000 7% cumulative preferred, later designated "Second Preferred," as a 200% stock dividend; and the Midvale Steel Company which in 1910 declared a 1,200% stock dividend, increasing the outstanding issue from $750,000 to $9,750,000, CHAPTER XXXII SURPLUS 341. The Nature of Surplus l The final item in our formula for income consists of "balance carried to the permanent surplus account." It is sometimes labeled "surplus for the period," but inasmuch as this phrase is applied also to what we have called "balance applicable to dividends and surplus," it is somewhat misleading and for this reason is not used. Much confusion of thought arises out of the continual inaccuracies and variations in the application of such terms as "income," "profits," "earnings," and "surplus." Until the general usage of this and many other business terms becomes more clearly settled, it will be impossible wholly to avoid this confusion. One term which should be clearly distinguished, however, is "surplus reserve." Surplus reserve, more frequently referred to simply as "surplus," is in effect simply an account or a group of accounts kept in the company's books which show the value of the equity belonging to stockholders over and above the par value of the outstanding shares. Like many other accounts, surplus is in part the result of valuations, or of a series of val- uations. If the estimate of value is judged by the directors or officers of the corporation to be wrong, it may be changed by a mere entry on the company's books. An instance has been cited in the preceding chapter of a publishing company, which increased its Good- Will account by $100,000 in order to inflate the Surplus account correspondingly so that a dividend might be legally declared. 2 In the section following, the various methods 1 For a more detailed discussion of the nature of surplus, see Book III, Part I, "Surplus and Reserve Accounts." > See $128. 908 Ch. 32] SURPLUS 909 through which a Surplus account may be built up are reviewed. For the immediate purpose, it is sufficient to emphasize the point that surplus reserve is in itself nothing more nor less than a formal and inconclusive appraisal of the shareholders' equitable interest in the corporation above the par value of their holdings of stock. ateaaA baxi' roorj \o 9/^:2 moi\ zulqiuS .^^ t 342. Sources of Surplus We have spoken of surplus in the preceding chapters as if it were always derived from earnings. Ordinarily this is so, but surplus may result from other causes as well. Five possible sources of surplus are given below: 1. Inheritance from previously absorbed corporations. 2. Sale of securities above par. 3 Sale of assets above their book value. 4. Revaluation of assets. 5. Accumulation of net earnings. 343- Purchased Surplus The first source of surplus is uncommon, inasmuch as most new corporations, even those which take over going businesses, carry the assets which they acquire at their full cost value no more and no less so that they start with neither a surplus nor a deficit; and this would seem ordinarily to be the correct procedure. However, there are occasional exceptions. Some years ago the Dominion Linens Company of Canada was organized with an issued capital stock of $250,000. The com- pany, according to a statement prepared by the well-known accounting firm of Price, Waterhouse and Company, showed assets of $267,684. After deducting a small amount of accounts payable, there was left a surplus at the outset of $14,138. It should be remarked, however, that among the assets was one item of "Good- Will, Trade-Marks, etc.," valued at $20,000. A surplus under such circumstances can hardly escape the suspicion of being more or less fictitious. It is scarcely safe to CORPORATE FINANCE [Bk. II- assume that the assets acquired are worth more than what was paid for them. The fact that these assets may have been carried on the books of the previously existing companies at a higher book value than was paid for them, has no bearing on the case so far as the new company is concerned. 344. Surplus from Sale of Securities or Fixed Assets The second source of surplus consists of the sale of securities above par. In such a case the corporation receives a greater sum than the nominal value of the obligations or the shares which it issues. This additional sum may be carried to an account called "Premium on Securities" or some such title, or it may be and frequently is credited direct to Surplus. It is clear ttyat a surplus which arises in this form is not to be regarded as a proper source of dividends, inasmuch as the premium on shares or bonds is in reality a contribution to the capital assets of the company. In this matter industrial and railroad corporations might profitably take a leaf from the practice of banks. In organizing new banks it is frequently agreed that every $100 share shall be sold at $150 or $200, or some other amount above its nominal value, so as to create a Surplus account at the outset. In this way the special liability usually imposed on financial institutions by the statutory law is provided for in advance and the surplus so created adds materially to the stability of the institution. As the bank earns profits, these are carried, not to the Surplus account, but to an account entitled "Undivided Profits" out of which dividends are declared. From time to time the directors may, more or less arbitrarily, transfer whatever sums they decide upon from the Undivided Profits account to the Surplus account. It is understood that credits to Surplus are not intended to be distributed, but are regarded as an integral part of the permanent capital of the institution. The third source of surplus is through the sale of permanent assets which are not intended for trading purposes, for a sum Ch. 32] SURPLUS above their book value. Frequently assets are written down aver a long period until their book valuation becomes only a small portion of their real value. To take an extreme and notable instance, the immensely valuable property of the Bank of England on Threadneedle Street, London, does not appear on the balance sheet of the corporation at all. 345. Surplus from Revaluation of Assets The fourth source of surplus is the revaluation of assets which have not been sold but are intended to be retained. This is a tempting expedient for a company which is running at an operating loss or with very small profits, and yet is under pressure to make a satisfactory showing. An extreme instance of this was the revaluation of the hemlock bark land of the United States Leather Company in 1902. This land had been bought at a fair market valuation almost ten years before. Since then prices of timber and bark had gone up and a com- mittee of directors reported that the bark property was worth about $14,000,000 more than its book value. In order to show this increased value on the books, without such an obvious write-up, the officials incorporated the Central Pennsylvania Lumber Company (all of the stock of which was owned by the United States Leather Company), which bought the timber (only) on the revalued bark land, giving in payment $16,000,000 of first mortgage bonds. The handling of timber properties so as to present a fair statement of the results that are actually achieved, always raises difficult questions. Taxes assessed against timber lands are frequently charged into an asset account in order to show the total carrying charges of the property. The continual rise in land values, and especially in the values of timber properties, has been so regular that this method has seldom been found disappointing. As to the revaluation of timber properties, it is thought by some authorities that there is no special objection in this case, provided the surplus thus created is put into a QI2 CORPORATE FINANCE [Bk. II- separate account and not treated as a part of the general surplus available for dividends. Coal lands are not infrequently revalued and the increased value added to surplus to be used for dividends if so desired. An instance of this is shown in the income statement of the Consolidation Coal Company in the preceding chapter. .lit . The question as to whether assets should be revalued or not, frequently arises also in the cases of banks and other finan- cial institutions which own large amounts of securities. On a rising market these securities may frequently have a market value much higher than their original cost, and the officers or directors of the company may desire that this extra value should be shown on the books and credited to Surplus. Independent accountants are usually strongly averse to this practice, on the ground that it makes a fictitious showing of profits. If the securities are actually sold and a profit is realized, then this profit will naturally go into a surplus account. Otherwise it is regarded as sound and correct to carry them at their cost valuation. It is not, however, inconsistent with this principle to insist that declinations in market value should be written off against surplus. It must be remembered that the Surplus account is at best only an estimate and that it is highly desirable to keep this estimate* always well within conservative limits. In operating an enterprise and selling its products, a valuable trait is the optimism that will carry a man forward through discouragements and temporary defeats. But in estimating the results and forecasting the future, it is necessary above all to be cautious and even skeptical. In general it is safe to say that the instances in which an upward revaluation of the permanent assets of a company is permissible, are highly exceptional and that in these exceptional cases the surplus thus created should always be plainly ear- marked so that there will be no mistaking its source. 3 1 For further discussion of this subject, see Ch. XXIX, "Net Income." Ch. 32] SURPLUS 913 346 Surplus from Earnings The fifth and most important source of surplus consists of savings out of the company's earnings. We have already seen that every year should yield a balance of profits above all fixed charges and above all dividends. This balance, if credited to Surplus year after year, will in time build up a large Surplus account. If the building up of this account is accompanied by consistent writing down of all assets of doubtful value, the balance sheet of the company will in time show an increasing and very substantial equity on the part of the shareholders. If surplus were only built up out of conservatively estimated earnings, it could be safely accepted as a fairly accurate measure of the real prosperity and solidity of the business. But surplus which comes from the other sources that have been named even though it may be a genuine surplus which has been realized gives no convincing evidence of earning power or of con- servative and able management. The term "surplus," therefore, in itself means little. It is merely the valuation the officials of the company put upon the corporate business and property in excess of the par value of the capital stock or book value if the capital stock has no par value plus any unencumbered reserves. It should always be examined with care, and its origin and its supporting assets should be determined before basing upon it any judgment as to the prosperity or good management of the company which shows it. 347. Policy as to Income and Surplus In discussing the desirability of establishing and maintaining a regular rate of dividends, it has been suggested that the only safe principle to follow is to fix the dividend rate below the estimated minimum earnings, thus making sure that it will be kept up year after year. This leaves all the extra profits of good years to go into surplus. If the company's business is of a highly stable nature so that the fluctuations in earnings are slight, it follows that the extra earnings of the good years gi4 CORPORATE FINANCE [Bk. II- will be relatively small and surplus will accumulate slowly. If the business, on the other hand, fluctuates a great deal, these dividends will absorb only a small proportion of average earnings, and the greater portion will remain as a credit to the Surplus account. This principle, therefore, automatically results in piling up a surplus almost in direct proportion to the degree of fluc- tuation of earnings. And this is as it should be. A company engaged in a business which enjoys steady earnings will have no trouble in raising fresh capital for any extensions that may be required and which can be shown to be clearly profitable. It is not necessary, therefore, that new capital should be pro- vided by savings out of earnings. On the other hand, a company the earnings of which fluctuate widely is, on the face of it, engaged in a speculative business and cannot easily secure fresh capital on favorable terms. Only through accumulations out of earnings can the business be extended and stabilized. The principle that has just been stated is of course put forward only as a general rule which is subject to innumerable qualifications and exceptions. First of all, it may be impossible to determine in advance what the minimum earnings are likely to be. Second, it may be desirable to use some discretion and diplomacy in dealing with stockholders and to satisfy their wishes from time to time by distributing a portion of the extra earnings of prosperous years, as extra or special dividends. For both these reasons the strict and inflexible application of the rule that has been stated is not always to be insisted upon. Most well-managed companies are satisfied if they reach some reasonable approximation in applying the rule. There is another qualification of still greater importance. In all that has been said as to this rule, it has been taken for granted that fresh capital can be taken into any business enter- prise and used as profitably as the original capital. In a great many cases this is true, especially if the fresh capital is not dumped upon the company in one or two big lots secured through Ch. 32] SURPLUS 915 the sale of securities, but is gradually added year after year and thus made available for betterments and extensions that are actually needed. However, even in those cases there may. after a time, come a limit to the development of the company beyond which fresh capital cannot be profitably applied. When this limit is reached, it is no longer desirable to accumulate surplus with rapidity. If earnings have not at that time been stabilized, it may be good policy to pay out most of the income year after year in dividends, allowing the dividends to fluctuate in close relation to the income. Or it may be adjudged better to fix the dividend rate at about the average anticipated income, in which case extra profits of the good years will be invested outside the company in short-term securities which will be sold when necessary in order to provide cash or dividends during the lean years. It is perhaps due to the fact that opportunities for expansion of successful enterprises in the United States are almost unlimited, that so much emphasis has been laid in our financial practice on the necessity of making large savings out of annual profits; whereas in European countries, where the oppor- tunities for expansion are more limited, the custom prevails of paying out most of the annual earnings in dividends and of relying upon fresh issues of securities to provide whatever new capital is needed. 348. Policies of Various Companies Sometimes the American policy of conservatism in dividends is carried to an extent which creates a remarkable disproportion between the Capital account and the Surplus account. The Atlantic Refining Company with profits of over $10,500,000 in 1920, paid dividends of $2,376,851; and with a total out- standing capital stock of $25,000,000, had a surplus of over $66,000,000. The Ford Motor Company at the end of the fiscal year, April 30, 1921, had a capital stock of $17,264,500, and a surplus of over $182,000,000. In addition to this it had reserves for depreciation, amortization, and taxes of over 916 CORPORATE FINANCE [Bk. II- $90,000,000. However, these unusual relations are to be ascribed, not so much to an extraordinary amount of savings out of income on the part of these two corporations, as to their omis- sion to follow the usual practice of revising their capitalization from time to time to conform to the increasing assets and earn- ings. Most prosperous American industrials save the greater part of their earnings, but through stock dividends and other processes of "watering" their prosperity appears in the form of enlarged capital accounts rather than enlarged surplus accounts. The Pennsylvania Railroad Company, in applying the principle that has been stated in the preceding section, endeav- ored for years to put at least a dollar into the Surplus account for every dollar that was paid in dividends. In other words, it has aimed to divide its balance of earnings, after providing for fixed charges, about evenly between dividends and surplus. During the twenty years ended January i, 1921, the company maintained dividends at 6%, with an occasional extra dividend of >% or i%. In spite of the Pennsylvania's highly conserva- tive policy, the critical railway year of 1920 forced a reduction of its annual dividend rate to 4%, at which it now stands. Its profit and loss surplus December 31, 1920, was $48,905,393, with outstanding stock of almost $500,000,000. 349. "Rainy-Day Funds" Some companies make it a practice to invest a portion of their saved earnings in securities or readily salable property, and hold these investments outside the business, as an insurance that dividends will be maintained. This practice is much more common abroad than in this country, although not wholly unknown here. For instance, the American Car and Foundry Company carries on its balance sheet a "Reserve for Common Dividends" of over $10,000,000. The great English steamship companies, which are peculiarly subject to heavy losses through the sinking of their vessels and similar accidents, have for many years made it a practice to build up surplus funds consisting of Ch. 32] SURPLUS 917 outside investments. These funds are intended as a kind of insurance against marine losses that cannot otherwise be insured and also for the purpose of "dividend equalization." In our owri country, the United Fruit Company carries investments in securities of over $19,000,000, presumably for the same purpose. One trouble with this policy is that it necessarily results in tying up a portion of the capital of the company in assets which yield only a small return. If the surplus fund is to be of any value for the purpose intended, it can be invested only in the best grade of marketable securities. Most companies which are prosperous and expanding do not feel that they can afford to take cash away from the business where it would bring profits of perhaps 10%, 15%, 20%, or more, in order to put it into securities that will yield at best 4% or 5%. Another objection is the fact that even this low yield does not necessarily guarantee that the company's capital put into investments will remain intact. The officials of a manufacturing enterprise are not expected to be investment specialists. A somewhat striking demonstration of this fact is given in the record of the Boston Belting Company, a long-established and substantial New England institution. Some years ago the company received in settlement of a suit, a sum of approximately $1,000,000. Inasmuch as the cash was not needed immediately in the business, and as it was not thought best to distribute it to stockholders, it was decided to invest it in certain securities, which were then considered high grade. These securities in- cluded 1,000 shares each of the stock of the New Haven Railroad and of the stock of the Boston and Albany, besides other shares and bonds. In 1914, as a result of the drastic decline in all securities, and especially in those which had been purchased, it was necessary to charge off over $400,000. Later an addi- tional $100,000 was written off, and half the reserve had melted away. It is true, of course, that the stockholders, if they had Deceived the cash, might themselves have made exactly the same mistake and would today be in no better position financially. 9I 8 CORPORATE FINANCE [Bk. II- But the feeling naturally exists that it would have been better for the company to distribute to the stockholders whatever cash was jiot needed in the business and to have remained strictly a manufacturing institution. In general, American thought and practice are not inclined to favor the diversion of capital and energy away from the essential and legitimate business of a company into outside investments. It is generally agreed that regular dividends combined with large or at least adequate savings out of annual income should.be features of the financial management of most corporations. However, this belief is based upon the assumption that the surplus thus credited is needed for the develpoment of the business and should in fact constitute the chief source of new capital. Wherever this assumption is unjustified, the general opinion would probably favor distribu- tion of profits even though the rate may be irregular. 350- Surplus as a Source of Capital In this country the accumulation of surplus out of earnings is conceived almost wholly as a source of fresh capital. As such it is to be contrasted with the policy of paying out all, or nearly all, the earnings in dividends and relying upon fresh issues of securities in order to obtain new capital when needed. The great advantage of securing capital through issues of securities is that it may be more quickly obtained and thus advantage may be taken of conditions which favor rapid develop- ment. Assume that two competitive corporations start to do business at about the same time with the same amount of capital, and that one corporation depends solely upon its ac- cumulating surplus for the capital with which to finance exten- sions, while the other corporation distributes most of its earnings in dividends but is successful in raising fresh capital by the sale of securities. If both corporations are able to work peace- ably side by side, it is probable that in the long run the first- mentioned policy will prove sounder and more profitable and that Ch. 32] SURPLUS 919 the stockholders in this first corporation will eventually reap the benefits of their self-denial. But possibly both corporations cannot work side by side. As they expand, one or the other J s certain to get the mastery, to capture the market, and to drive its competitor out of business. Under these conditions it may well be that the second corporation, through its policy of selling securities, may be able to raise needed capital more quickly and thus secure the dominating position which is the goal of both, before the first corporation has made a good start. Somewhat similar conditions frequently exist. A corpor- ation formed to manufacture and sell a new device may find it vitally necessary to cover its field before some other device can be brought out and introduced as an effective competitor. Or a company may have in hand a project which is peculiarly timely, such as accepting a new and profitable contract. In all cases where the element of time in developing a business is a factor of great importance, the advantage as between the two methods rests with the plan of issuing securities. The great advantage, on the other hand, of securing capital through savings consists of the steadiness and soundness with which the business may in this way be developed. It will not suddenly spurt ahead perhaps before adequate preparation has been made or before an effective organization can be brought together. It will grow, year by year, adding a new piece of machinery here, erecting an addition to its plant there, gradually increasing its organization until some day, almost to the surprise of its own founders, it finds itself a leader among its competitors. Something like this, as has already been intimated, was the history of the Carnegie Steel Company; a still more striking instance of inside financing is furnished by the history of the Ford Motor Company in fact, this has been the history of probably 75% of the great industries of the country. The other 25% have been built up chiefly by the more rapid, more attractive, and more dangerous process of bringing together great sums of capital through the issuance of securities. 920 CORPORATE FINANCE [Bk. II- 351. Hidden Surpluses The somewhat doubtful sources of surplus discussed in the earlier part of this chapter may properly be taken to indicate reasons for questioning the validity of the surplus accounts which appear on the balance sheets of many corporations. If these alleged surpluses are based on revaluations of the com- pany's assets or are derived from statements of earnings that have been exaggerated over a series of years, it may easily happen that on searching analysis and examination they will vanish into thin air. There is plenty of reason for a questioning attitude on the part of purchasers of securities when they are supplied with a surplus statement. On the other hand, many old and well-established corpora- tions may properly be said to have "hidden" or secret surpluses. The situation arises out of the practice over a series of years of understating net income; of making larger provision than is necessary for reserves; of writing down drastically the book values of assets, both tangible and intangible. The result ob- viously is that the balance sheet shows an understatement of the value of the company's assets; and this understatement constitutes a hidden surplus. If the balance sheet were revised so as to show the true values of the company's assets, the Surplus account would be correspondingly increased. In theory, the practice of understating the values of assets and carrying hidden surpluses is just as objectionable as the practice of overstating values. The real aim of the accountant and of the financial manager should be to see to it that the balance sheet tells the exact truth neither more nor less so that every creditor, every prospective purchaser of securities, may take action with his eyes open. However, this ideal is not attainable, and since there must be an error on one side or the other, it is better to err on the side of understatement and over- conservatism. Bankers and careful investors place a high value on a balance sheet that gives evidence of having been prepared with extreme caution or even pessimism. Ch. 32] SURPLUS 921 Banking houses and sometimes other firms as well find it useful to carry certain surpluses in the form of undervaluations of securities and other assets in order to take care of exceptional losses without disturbing the appearance of the balance sheet. If a bank suffers a serious defalcation, for example, it may be highly injurious to its credit to charge the whole amount directly against surplus, thus advertising to its customers and the world at large that it has met with a set-back. In case the bank has been carrying assets at an undervaluation, it may resort in such a case to a revaluation of these assets so as to increase them by approximately the same amount as the loss that is to be written off. When the next balance sheet appears it shows no difference except that the skilled analyst might be able to detect changes in the valuations of assets; but this is not usually possible. CHAPTER XXXITI BUDGETARY CONTROL 352. Nature and Types of Budgets In handling governmental business in nearly all civilized countries, it is customary for the executive power to submit to the legislative power a detailed estimate of the prospective revenue and outgo for the succeeding fiscal year. This esti mate is know as a budget. It may be described as a detailed income and expenditure statement made out in advance of the period which it covers; it is a prediction or a guide, not a record of results. In governmental practice it is customary to secure the approval of the legislative power, and thereupon the adopted budget becomes an appropriation of the expected revenue. The various departments of the government are not authorized to go beyond the budget sums for their departments in their expendi- tures for the fiscal year. In private corporations the budget, except in rough and frag- mentary form, has not been generally used. There is a growing interest, however, in the application of the principle of the budget with a view to forestalling the serious financial errors and miscalculations that so frequently wreck the careers of otherwise successful corporations. It should be possible to make detailed financial plans and schedules for a year or more ahead, just as it is possible for many companies to make detailed operating plans and schedules. Budgets are divisible into two classes: those which are merely estimates for the benefit of the active financial managers, and those which are adopted and definitely determine appropriations. When the budget plan is to be introduced, it is usually best to start with the first class unless there is some emergency which 922 Ch. 33] BUDGETARY CONTROL 923 demands that a definite financial plan be at once adopted and adhered to always having in mind the expectation that the budget will in time reach the stage of being either formally adopted or accepted by general agreement as stating the limit for the year's expenditures. 353- Need of Budgetary Control In spite of the obvious advantages of making a forecast of financial operations each year, the budget plan, as stated above, has not yet been generally adopted. It is true, however, that estimates for a year or more in advance (which are a crude form of budget) are customarily made by careful financial managers. When the budget is not used in a more or less complete form, it is usually (i) because its advantages are not appreciated, or (2) because of the inability of the management to install and operate it. The budget in some form is almost essential to proper admin- strative control. It operates in two ways : 1. To co-ordinate the activities of the various functional departments. 2. To serve as a basis for centralized executive control. 354- Working up a Budget The ' following outline of the procedure to be followed in the installation and operation of a budget gives an excellent idea of the requirements and the successive steps to be taken.* This procedure will of course be varied according to the organi- zation of the business and the nature of its operations. i. ESTIMATE OF ACTIVITIES Each department prepares an estimate of its activities for the budget period. The method of stating these activities depends on the nature of the operations of the department. The sales department states the sales it expects to make and the estimated i By permission from "Budgetary Control," by J. O. McKinsey. 924 CORPORATE FINANCE [Bk. II- expenses it will incur in making these sales. The production de- partment states the estimated production for the period and the requirements in material, labor, and manufacturing expenses to meet this estimate. The service departments, such as the per- sonnel department, the traffic department, the accounting depart- ment, and the office manager's department, state the estimated expenditures of their departments. Because of the interdepen- dence of these departments, some will need to use the estimates of other departments in making their own estimates. For instance, the production department must know the estimated sales before it can estimate the production necessary to meet the sales demands; the treasurer must know the plans of all the departments before he can estimate his cash receipts and cash disbursements. Con- sequently a procedure must be set up which provides for a proper scheduling of the estimated with reference to preparation and distribution. 2. COMBINING THE ESTIMATES The departmental heads will transmit the departmental es- timates to an executive who has supervision of the budgetary procedure. Sometimes the comptroller acts in this capacity, while in many cases the duty is delegated to a member of the staff of the general manager or president. Since many businesses do not have a comptroller, it will be assumed during the present discussion that an assistant to the president acts in this capacity. This official combines the estimates of all the departments into a proposed financial budget for the business. In preparing this estimate he will be assisted by the treasurer, though in some cases this budget is prepared by the treasurer alone. The proposed financial budget should show the estimated receipts from all sources and the estimated expenditures by all departments of the business. 3. ADJUSTING RECEIPTS AND EXPENDITURES The executive in charge of the budget procedure makes a com- parison between the estimated receipts and the estimated expen- ditures as shown by the proposed budget. If the estimated expen- ditures exceed the estimated receipts, one of the following courses of action must be taken: (a) The departmental expenditures may be reduced. In mak- ing such reductions a problem arises due to the fact that the reduc- tion of expenditures may result in a reduction of receipts. For Ch. 33] BUDGETARY CONTROL 925 instance, if the expenditures of the advertising department are reduced, this may result in a reduction of sales, with a consequent reduction of receipts from collections. In the same manner, a reduction of the expenditures of the production department may result in a reduction of production with a consequent lack of goods to meet sales demands which will result in a reduction of receipts from sales. Care must be taken, therefore, in the reduction of expenditures to see that receipts are not reduced more than proportionately. (b) Additional receipts may be secured. It may be possible by speeding up operations and securing more efficient administration, to secure additional receipts without incurring a proportionate increase of expenditures. (c) Additional capital may be secured. If it is not deemed wise to reduce expenditures, plans must be made to secure additional capital with which to finance the excess of expenditures over re- ceipts. It is understood, of course, that this condition cannot continue long, otherwise the business will find it necessary to liquidate. The executive in charge of the budgetary procedure may make recommendations with reference to possible procedures, but he is usually not invested with authority to determine the plans to be followed. 4. PREPARING THE FINANCIAL STATEMENTS The executive in charge of the budgetary procedure prepares from the departmental estimates an estimated balance sheet and an estimated statement of profit and loss, showing respectively the anticipated financial condition at the end of the budget period and the anticipated result of the operations of the period. 5. ADOPTING THE BUDGET ITS EFFECT The departmental estimates, together with the proposed finan- cial budget and the estimated financial statements, are submitted by the executive in charge of the budgetary procedure to a budget committee, composed of the principal executives of the company and presided over by the president. This committee considers the proposed estimates and makes such revisions as it thinks necessary. In case* the proposed budgets involve important changes in the company's policy or require the securing of addi- tional capital for a material amount, it may be necessary to submit 926 CORPORATE FINANCE [Bk. II- them to the board of directors for approval. After the proposed estimates have been approved they constitute the working program for the budget period. The budgets as adopted set limits upon the expenditures of all tne departments, and these limits cannot be exceeded without the permission of the budget committee. The budgets also set up standards of performance for certain depart- ments. For instance, the sales budget states the sales that are to be made by the sales department, and the production budget states the estimated production of the production department. There is no particular secret or trick about the making of a budget. All that is necessary is to marshal the facts of past experience in orderly array, combine them and use them with care and common sense as a guide to the activities of the business. While it may not be possible to accomplish the estimated results, it will certainly be a source of satisfaction to approach them as closely as possible. With each succeeding effort the margin of error should be decreased, 355. Sales Estimates as a Basis for Budget-Making A constantly recurring objection, not only to formal budgets, but even to advance estimates, is that the volume of sales of most corporations is not under control, nor can it be foreseen. There is undoubtedly truth in this assertion. Yet in the great majority of cases this difficulty is exaggerated. As a matter of fact, the manufacturer or trader should be able, within reasonable limits, to exercise a fairly close control over the volume of his sales; if not, his business is clearly on an extremely unsound basis. His percentage of sales expense to gross profits has presumably been definitely determined by past experience, or at least the normal percentage in his line of business must be known. While it is true that he cannot abruptly increase his business by the mere process of increasing his selling expenditures, he should be able to count, with some definiteness, upon certain steps looking toward the building up of his selling organization which should result in a proportionate increase in volume of business. It is, of course, further true that in many lines of business Ch. 33) BUDGETARY CONTROL 927 extreme fluctuations take place from year to year, due to causes over which the industrial or trading corporation has no control. Manufacturers of railway supplies, for example, are able to sell more of their product when the railroads are prosperous; and no amount of extra selling effort will prevent sales from falling off when business conditions are at a low point. To say, however, that these fluctuations will necessarily take place is not equiva- lent to saying that they cannot be foreseen. The budget-maker is not primarily engaged in planning to build up sales or regulate operations; it is his main business only to form a careful estimate of what the results of the company's expenditures are likely to be. In determining these results, he may give proper weight to all of the unfavorable, as well as the favorable factors. If he is a really capable financial man, he will look forward to the prob- able economic conditions of the coming year and determine with some degree of accuracy whether they are likely to be favorable or unfavorable to his company. Having in view, then, these three factors: (i) estimated ex- penditures during the coming year directed toward building up sales; (2) normal percentage of sales expense to volume of sales; and (3) probable effect of general business and financial condi- tions and other external forces on his line of business the budget-maker should be able to form a much clearer estimate of the volume of business than would at first seem possible. Once the anticipated volume of business is calculated, it is comparatively simple to calculate the expenses that are necessary in order to handle the estimated volume. The uncertainty as to the result of selling effort is the crucial difficulty to be overcome. 356. Effect on Budget of Fluctuations of Business A related objection to budget-making sometimes raised, is to the effect that the business cannot be expected to run in a uni- form channel month after month, but will fluctuate widely, whereas the budget is usually based on the assumption of some degree of uniformity; consequently, it is said, the budget gives 928 CORPORATE FINANCE [Bk. II- a false notion of the actual course of affairs, even though it should by chance be fairly accurate in its prevision of total business for the year. This objection is of no vital importance. It tends simply to show that the budget should, in the first place, be made on a monthly rather than on a yearly basis, with a view to increasing its accuracy, and in the second place, should allow a reasonable margin for errors and unforeseeable fluctuations. 357. Budgetary Red Tape A third objection to all Lu.'gets is the restrictions they im- pose upon the free judgment anJ action of operating officials, wh ch are so essential to an energetic and growing enterprise. The obvious answer to this objection is that the free, un- trammeled and unco-ordinated activities of sales managers, buyers, superintendents of factories, and other operating officials, has been probably the most prevalent single cause of financial embarrassments. One of the- main purposes of the budget is to bring the various official activities into harmonious relation, not only with each other, but also with the financial policies and the financial resources of the business. If the establishment of a necessary and proper relation, and the insistence upon it irritates operating officials and makes them feel that they are unduly restricted, it is only because their interests are too nar- row. They are attending to the up-building of their own de- partments without having a real understanding of the situation and the needs of the business as a whole. As a matter of fact, a definite and binding budget, which can be debated and settled by all the responsible officials and the directors of a company at the beginning of a fiscal year, is a highly effective method of securing the singleness of purpose which is an essential factor in every efficient organization. 358. Flexibility of the Budget The objections to the budget and budgetary control are largely based on the assumption that a budget once adopted is an Ch. 33] BUDGETARY CONTROL 929 absolutely inflexible and unchangeable strait-jacket from which no relief can be obtained until after the expiration of the fiscal year in which it holds good. If this were actually the state of affairs, the objections would have weight. But the efficient budget, as used by some corporations, is subject to continual revision. First of all, it may be made both on a yearly basis and on a monthly basis. The yearly budget enters into few details, but gives a comprehensive view of the anticipated income from various sources and the anticipated expenditures of this estimated income, together with the approximate result of the whole year's business. Supplementing the yearly budget and controlled by it, are the monthly budgets, which enter into as much detail as may be required by the nature of the business, and make due allowances, so far as they can be foreseen, for the seasonal and month-by- month fluctuations which occur in every business. The month- by-month budget may be checked up at the end of each month against the actual results of that month ; the causes of discrep- ancies may be noted; new contracts or prospects for enlarging or reducing business during the months immediately following may be taken into consideration. With all these and other similar factors in full view, such revisions of the budget as are at the time required may readily be agreed upon. It is quite probable that during the year wholly unexpected circumstances may arise which may make it necessary to discard the previous estimates and to make entirely new estimates. The point toward which the business vessel is being steered may for such reasons be altered. It goes without saying that no budget cr any other arbitrary set of figures should be permitted to stand in the way. But the fact remains that the vessel is actually being steered and is not merely drifting. The budget is the chart which the financial manager is expected to follow until he finds that new circumstances make a new or revised chart essential. 930 CORPORATE FINANCE [Bk. II- 359. Income vs. Cash as a Basis for the Budget A practical question that must be answered before the budget can be prepared, is whether it should be based upon income and expenditures or upon cash receipts and cash disbursements. Income and expenditure constitute the correct measure of profits, and therefore should be used whenever the prime purpose of the budget is to control expenditure and to insure a satisfactory showing of profits during the ensuing year. Cash receipts and cash disbursements, on the other hand, measure the financial status and financial prospects of the business and should be used whenever the prime purpose is to make sure that the business will run on a basis that is financially sound. In many lines of business the distinction is not of great im- portance, for the reason that the income and expenditure oi sach month tally closely with the receipts and disbursements of the month. But in other lines it would be disastrous to overlook the distinction. In reply to an inquiry on this point, a certified public accountant of high standing writes: It seems to me that all successful plans for business must con- template both prospective income and expenditure and prospective receipts and disbursements, and that emphasis as to which of the two is more important depends to a considerable extent upon the business. For example, .... in the business of making fertilizers, probably 85% of the business is done on long terms and the realized income receipts at the time of the greatest manufacturing activity are comparatively small. In such a case the income and expen- diture features are those which are mainly considered. These same facts apply to a considerable extent to the conduct of the farm implement business. On the other hand, any concern doing a strictly trading busi- ness, with little or no manufacturing, looks more to the expected receipts from current sales than to the anticipated income arising through a longer period. Nevertheless, even in such cases, es- pecially where goods are bought on time, the anticipated income has to be considered in determining the amount of obligations which are incurred. For these reasons I am led to think, speaking Ch. 33] BUDGETARY CONTROL 931 broadly, that in the cases where a considerable part of the business, whether of sales or purchases, is done within a short period, the income and expenditure features demand the larger consideration, for broad plans must be devised for the whole year's business. Where the business, however, approaches more nearly to regular periodical turnovers, the receipts and payments become more important. 360. Cash and Income Budgets The best answer to our question would seem to be that in all cases except those in which income and expenditure and receipts and disbursements are practically identical, there should be two separate budgets. The income and expenditure budget should be for the guidance of all the operating officials of the company; it should show in some detail the amounts that may be expended and the results that are expected in each department. This is the budget that serves the purpose of facilitating control. The receipts and disbursements budget may be only for the private information and guidance of the treasurer or of those who are responsible for the financial management of the company. It will indicate just where the actual cash receipts of each month are to come from and through what channels the cash is to flow out. The budget of cash receipts and expenditures may itself be divided into two parts, the first part including only those trans- actions which have to do with current operations, and the second part including only capital transactions. By combining the two parts the financial management may look ahead and make cer- tain that ample bank balances will be maintained; calculate to what extent they will be dependent upon bank and other loans; determine exactly how far they should go in taking advantage of cash discounts; and otherwise guide the financial course of the company with skill and accuracy. The blundering and indecision which so often mark the relations, between business enterprises and their banks, and which so often lead to impetuous and urgent demands for fresh 932 CORPORATE FINANCE [Bk. II- capital in order to avert serious embarrassment, could for the most part be avoided through the use of careful budgets of forthcoming receipts and disbursements. 361. Calculating the Income Taking up now in more detail the procedure in forming a budget, first on the income and expenditure basis, and second on the receipts and disbursements basis, we have to consider the extent of the income for the period (whether it be monthly, half- yearly, or yearly) which may fairly be regarded as assured Manufacturing companies are likely to have certain regular customers on whom they may safely count, unless extraordinary conditions prevail, for a given amount of business. The same thing is true of wholesale trading companies. The companies, both manufacturing and trading, which are selling at retail, can at least work out from their own records the minimum limits of their sales. The same thing may be done by public service and transportation companies. Companies which operate on long- term contracts extending over two or three years or more may conceivably be in the position of having all their capacity occu- pied with work giving them an assured income. Most companies have in addition certain possibilities which require careful study and good judgment in order to make a reasonably accurate estimate of earnings which are not assured but are probable. In these estimates, the financial manager will naturally be guided to a great extent by the views of the sales manager and other operating officials who are probably in closer touch than he is with the company's sources of income. It is well to state separately the amount of gross earnings which may be regarded as probable but is not assured. It may or may not be advisable to make still a third classifica- tion which will include the additional earnings that are within the range of possibility, but cannot conservatively be called "probable." Naturally the form in which these earnings appear in the budget will depend upon the business. Ch. 33] BUDGETARY CONTROL 933 In given instances it may be well to show considerable detail as to the exact basis of the estimates of earnings. However, if sufficient detail is not given in the budget itself, it should be at hand and should be subject to the criticism of the operating officials, with a view to making it as complete and accurate as possible. 362. Calculating the Expenses The classification of expenses should follow the same lines of division. It is well to estimate, first of all, what may be called the fixed and necessary expenses of the business, assuming usually that it is intended to hold intact the organization that has been built up. These necessary expenses will include, therefore, the salaries of officers and their assistants, of salesmen, clerks, and working men, the purchases of raw materials necessary for pro- duction up to the amount that is assured, the up-keep of the plant, and other necessary expenses. A second section will show the increase in expenses necessary in case the probable volume of business, as previously estimated, is secured. A third section will show further increases necessary in case the possible volume of business is attained. An income and expenditure budget made up in these three divisions will prove, it may safely be said, a remarkably inter- esting and helpful guide. Possibly the threefold division may be necessary only for the annual budget, while the month-to- month budget may relate wholly to probable earnings. These are matters of detail. The important point is to get the budget so arranged and in sufficient detail to show what may reasonably be anticipated without incurring the danger of imposing undue or arbitrary restrictions on the initiative of the various officials and department heads. 363. The Cash Budget The receipts and disbursements budget may be arranged in three divisions to correspond; or it may be necessary to base it 934 CORPORATE FINANCE [Bk. II- wholly upon the estimate of possible earnings. In those lines of business, however, in which sales are made on a long-term or instalment basis, it will be found of the highest importance to make the receipts and disbursements budget in considerable detail and with a view to all possible contingencies. Not to do so is to invite serious trouble, for an enlarged volume of business in such industries necessarily means a proportionate, or more than proportionate, tying up of cash resources. A budget may even indicate that for this reason it is unwise to attempt to handle the volume of business which the sales manager and operating officials would like to secure. The making of a receipts and disbursements budget may be sufficient in itself to reveal the breakers ahead and to inspire caution. 364. Where a Budget Might Have Prevented Failure A remarkable example of lack of foresight in handling the affairs of a prosperous business is to be found in the record of the M. Rumely Company, large manufacturers of farm machinery, which became embarrassed in the spring of 1913 and was reor- ganized a few months later. The first report of the president of the reorganized company, C. S. Funk, which covers the fiscal year ended December 31, 1913, is remarkable in its clear-cut analysis of a bad financial situation. The business of the company was transacted by selling agri- cultural implements, through agents, to farmers and accepting instalment notes from the farmers in payment. The company in turn issued commission certificates to the agents, which were due and payable when the notes for the sale on which the com- mission was paid matured. As a certain percentage of these notes were not paid promptly at maturity and considerable collection expenses were required, it was necessary to carry a reserve against them. The heavy loss during the year preceding reorganization, which amounted to $1,407,000, was explained in part by the lack of co-ordination between the sales and manufacturing depart- Ch. 33) BUDGETARY CONTROL 935 ments. During the early months of the year, owing to the forcing of sales, the factory had to run night and day, which involved excessive piece rates, unskilled help, and waste at every point. On the other hand, during the latter part of the year, the factory was shut down, the loss from manufacturing alone approximating $1,100,000. The report says: In the Sales Department a fundamental mistake was made in complete misjudgment of the market for Rumely products and the rate of gross which could be safely attained. The reduced volume of business should have shown a reduction of sales expense of $600,000, to maintain the same ratio which held in 1912, but there was an actual increase of $600,000, thus making a relative increase of $1,200,000. Interest charges were increased by over $800,000, due to an excessive inventory and the high interest necessitated by the company's condition. The company's embarrassment was directly due to the ac- cumulation of a large inventory of raw material, goods in process, and finished products, to the amount of $16,500,000. The expected increase in the company's business failed to materialize and the sales expense was greatly increased "in an ill-advised effort to dispose of this product." Surely a little foresight and care in drawing up a cash budget prior to the beginning of the year 1913 would have been sufficient in itself to assure a reasonable degree of co-operation between the sales and manufacturing departments during the year, and such foresight would have prevented the extraordinary absorption of cash reserves in running expenses and inventories which in- evitably culminated in receivership. ~tn no CHAPTER XXXIV EXPANSION 365. Capital Requirements At the inception of an enterprise provision must be made for both fixed and working capital working capital for the active current operations of the business, and fixed capital for invest- ment in its plant, equipment, and other more permanent re- quirements. After a business is organized its operations may increase, and demand larger amounts of working capital, and these same en- larged operations may require larger investments of fixed capital. This additional fixed capital may be provided from outside sources, or the business may have been so profitable that its own surplus supplies the fund for extension. In any event, if addi- tional fixed capital is to be invested in an extension of the busi- ness, it will usually be expended along one of the following lines : 1. Extensions of the original plant. 2. Increases or changes in equipment. 3. Additions of side lines. i>nj These three lines of extension are considered in the present chapter in the order given. ' 366. Expansion as a Cause of Disaster Expansion is the natural outgrowth of any active, aggressive business. Instances are seen on every side, and if undertaken with discretion and good judgment, such expansion is com- mendable and usually successful. Unless, however, expansion is wise, it is not only injurious to the business, dissipating its energies and resources, but frequently leads to disaster, 936 Ch. 34] EXPANSION 937 One of the most curious instances on record of a disastrous investment on the part of a corporation in extending its own business, is that of the Assets Realization Company. This company was organized for the specific purpose of giving financial relief to embarrassed concerns, by taking over the assets which they could not otherwise dispose of. It is frequently possible to purchase from such concerns plants, machinery, securities, and other assets of great value, at bargain prices. It was the expectation of the organizers of the Assets Realization Company that they could take their choice among properties thrown on the market in this way, and could rehabilitate them or adapt them to other uses or see to it that they were managed in a more efficient manner, and in this way realize large profits for them- selves. The plan seemed fundamentally sound, and for some years the Assets Realization Company was successful. As it proceeded, however, the company gradually extended its opera- tions into the underwriting of securities of new corporations which for one reason or another could not be marketed. Further- more, it is stated that some of the assets which had been taken over from insolvent corporations could neither be utilized nor resold, and remained as a dead weight on their hands. Eventu- ally the company became afflicted with the same disease which it had undertaken to cure, and was itself so loaded down with unrealizable assets that it was finally compelled to go into the hands of receivers. It had extended its business beyond the limits of prudence, 367. Unwise Expansion A somewhat similar experience, though not with the same disastrous ending, was that of the United Retail Stores Corpora- tion. It is an interesting retrospect of what seems to have been an unwise expansion. As given in the Wall Street Journal: 1 At the outset organizers of United Retail Stores Corp. an- nounced plans for the extension of a manufacturing business and > March I. 1922. 938 CORPORATE FINANCE [Bk. II- retaii chain of stores throughout the world. This was started with the acquisition of United Cigar Stores Co. of America as nucleus and it was planned to apply on a larger scale the principles of retail- ing which has been developed and proved successful in that chain. .',f HM'.; : ' ;;;' : .': ,: ' FOUNDERS' SHARES ISSUED AT $5 There were 160,000 founders' shares issued to those identified with the management at $5 a share, to rank equally with the class "A" shares in dividend distributions. These dividends were to be accepted in lieu of salary or other compensation by officers and directors. Organizers subscribed for 50,000 class "A" shares of no par at $70 a share and approximately 508,000 shares additional were issued in exchange for 254,000 shares of United Cigar Stores com- mon at ratio of two for one. This made a total of 558,000 class "A" shares outstanding and 160,000 founders' shares. Thus the founders increased capitalization immediately by 28% and placed the holders of these shares in a position to receive 22% of the dividends paid by United Retail. INVESTMENTS UNPRODUCTIVE The $3,500,000 received in subscriptions for stock sold has gone into investments which thus far have been unproductive. In the reorganization of Montgomery Ward & Co., United Retail pur- chased half of the issue of 850,000 shares of no par common at $30 a share. It sold part of these to an underwriting syndicate at $40 and when the transaction was completed Retail had left 170,000 shares at an outlay of $2,550,000 or an average of $15 a share. Then 400,000 founders' shares of United Retail Candy were pur- chased at $i a share. This placed Retail in a position to share approximately 40% of the candy company's profits, and involved an investment of $400,000. Then Retail acquired at an expen- diture of approximately $1,500,000 an interest in Gilmer, Inc., operating a chain of cash retail stores in the South. These invest- ments involved $4,450,000, which not only absorbed the $3,500,000 realized on the sale of the 50,000 class "A" shares, but left it with obligations at the banks December 31 last totaling $1,611,000. MONTGOMERY WARD'S LOSSES Montgomery Ward & Co. in the two years following the invest- ment by Retail lost $20,000,000. Retail Candy thus far has shown substantial losses. During the period of readjustment, Gilmer Ch. 34] EXPANSION 935 found it necessary to take inventory losses, and though its business appears to have turned the corner, it is not yet yielding Retail an income. With stock dividends, Retail's holdings of United Cigar Stores have been brought up to 308,000 shares. Retail has paid two stock dividends of 5% each, in which the founders' shares par- ticipated, bringing total class "A" outstanding up to 633,100 shares. OTHER COMPANIES ORGANIZED In connection with the proposed worldwide retail-manufactur- ing scheme, A. T. Securities Corp. was formed and acquired, by exchange of stock, common shares of American Tobacco Co. This was subsequently dissolved. Another company of which little has been heard, International Trademark Corp., made its appearance on the New York Curb market, but no detailed announcement was made in this connection. Efforts were also made to acquire foreign tobacco monopolies. United Retail was organized in the peak of wartime inflation and its investments were made under these unfavorable conditions. The net result has been $4,450,000 of unproductive investments, a bank debt of over $i ,600,000 and United Cigar Stores left to carry the load with 633,100 class "A" shares and 160,000 founders' shares, a total of 793,100 shares compared with Cigar Stores' actual capitalization of 328,653 common shares. Shareholders of United Retail who exchanged their United Cigar Stores common find holders of founders' shares receive approximately 20% of the dividends paid out of the Retail's earnings from disbursements on United Cigar Stores common. At the same time United Cigar Stores Co. has its usual overhead, while a shareholder in United Retail has to carry the additional overhead of the founders' shares. 368. A Sound Expansion Policy Many large corporations have been led astray by the idea that it was necessary for them to extend their business by attempting to buy up all competitors. The chief result has been that they have "held the bag" for all kinds of trouble-making schemes. The contrary policy is ably set forth by A. W. Green, then chairman of the company, in the annual report of the National Biscuit Company for 1901. The fact that the company 940 CORPORATE FINANCE [Bk. II- has paid regular dividends of 7% on both its common and pre- ferred stock for many years past and now has a surplus of over $20,000,000, indicates the wisdom of the policy. Mr. Green says: When the Company started it was believed that we must control competition, and to do this we must either fight it or buy it. The first meant ruinous war of prices, the second constantly increasing capitalization. Experience soon proved to us that instead of bringing success, either of these courses, if per- severed in, must bring disaster. This led us to ask ourselves whether the Company, to succeed, must not be managed like any other large mercantile business. We soon decided that within the Company itself we must look for success. We turned our attention and bent our energies to improving the internal management, to getting the full benefit from purchas- ing our raw materials in large quantities, to economizing the ex- pense of manufacture, to systematizing our selling department, and above all things to improving the quality of our goods. It became the settled policy of this Company to buy out no competition, and to that policy, since it was adopted, we have steadfastly adhered and expect to adhere to the end. 369. The Chain Store Plan of Expansion Another very common fallacy on the part of manufacturers is the notion that they must handle their own retail outlets, and to do so must build up a group of chain stores. This policy has in fact been successfully followed by many important companies, such as the George E. Keith Company, manufacturers of "Walk- Over" shoes, the Regal Shoe Company, the W. L. Douglas Shoe Company, Huyler's, Page and Shaw, etc. In practically every such instance, however, it will be found that the policy has been followed as a means of protection, not as a profit-maker in itself. The dangers of extension along this line are not to be minimized. The manufacturer, in the first place, is going into a line of busi- ness with which he is not familiar and where it is difficult to avoid numerous pitfalls. In the second place, he is likely to find that the move brings him the active hostility of the retailers who Ch. 34] EXPANSTON 941 have previously served as his agencies, thus making it necessary for him to develop his chain of stores more rapidly than he had anticipated and to invest more money than he had originally counted upon. It is a fact often commented upon that successful corpora- tions, as they expand, ordinarily tend to earn smaller and smaller returns on the actual value of their property. One common explanation is that at the beginning one or two managers exercise close personal supervision over the whole enterprise, and direct it by their insight and wisdom into the most profitable channels; whereas later their duties are necessarily delegated in part to men of less ability. The economist offers in explanation of this falling off in the percentage of return, the "law of diminishing returns" which is simply the principle that the most advantageous opportunities for utilizing capital and energy are taken at the beginning, and the less advantageous opportunities are left for future develop- ment. Yet neither one of these explanations applies in the case of many corporations which are ably managed and which con- tinually raise and invest fresh capital without decreasing the average rate of return. Modern methods of organization and management and the advantage of being able to employ special- ized talent go far toward offsetting the first difficulty above named. As to the economic principle, it applies, to be sure, but only after the industry has been so far developed that all its highly advantageous opportunities have been sought out and utilized a condition which obtains in very few lines of business. We may safely infer that one important cause for a decline in the rate of return is to be found in the strong tendency to make extensions of original businesses along lines that are not wisely chosen. The results of each move are not foreseen and calculated with suf- ficient care. As an example of profitable extension on a great scale, we may take the case of the General Electric Company. During 942 CORPORATE FINANCE [Bk. li- the nine years, 1905-1913, the capital stock increased from $48,000,000 to $101,000,000. However, $23,000,000 of this increase represented a stock dividend in 1912, which left only $20,000,000, or slightly over 40%, as an actual increase of in- vested capital. During these nine years, the profits applicable to dividends doubled and the gross sales nearly tripled. Since then the capital stock has been increased to $139,026,900. At the end of 1920 the company had a working capital of over $145,000,000 and a surplus of over $70,000,000. Its profits for that year available for dividends were over $22,000,000. All this has been accomplished by steady progress in extending the business along lines that had previously been mapped out. It is an inspiring record of what may be accomplished by persistent and consistent effort. 370. Investing Capital in Betterments One of the frequent causes of embarrassment to corporations which take over going concerns, or which are formed in order to combine previously existing concerns, is the discovery that the supposed net earnings of the acquired concern have been achieved through failure to maintain the property in first-class condition. Of course, if the investigation has been sufficiently thorough, this fact will be discovered before any entangling alliances have been formed. However, the truth is that such investigations fre- quently are carried on in slipshod fashion, or may even be omitted altogether. Cases are not uncommon where important com- binations have been formed on the strength of the unsupported statements of earnings submitted by each of the constituent companies. Even within a going and apparently successful corporation the same condition may exist. If the direction of affairs is left wholly in the hands of the active officers, they will net be over- anxious to disturb their showing of profits by setting aside ample sums to offset depreciation and to maintain the property ; at its full value. Ch. 34] EXPANSION 943 It must be borne in mind in this connection that making repairs from time to time is not enough. If competitors are installing new and more efficient machinery, it is not sufficient for the company to keep its old machinery in good repair. The more efficient machinery must be installed if its position is to be maintained. At some later date, when the fact becomes known that large amounts are urgently required to bring the property back into first-class condition, both the stockholders and the directors are loath to give up or even reduce their divi- dends to atone for the errors of the past. Instead, the idea of raising new capital to provide for betterments will meet with favor. It will be argued in favor of this view, that betterments represent a capital expenditure which may properly be provided through the issuance of fresh securities. This may be true, but the needed expenditures now accumulated in a lump should have been met out of profits over a series of years. It is also probable that fresh capital invested in bringing the plant and machinery up to a reasonable degree of efficiency will not materi- ally increase the profits, but will merely have the effect of pre- serving or restoring the profits the concern had theretofore been earning. The question as to when betterments constitute a legitimate capital expenditure and when they should be met out of earnings, is naturally always debatable. Conservative management tends strongly to decide the question in favor of the second alternative. When it is not so decided, there is always a danger at least of investing fresh capital in a form that will bring little if any returns. The statement is so obvious that no illustration is needed to enforce it. Its importance, however, should not be overlooked. norn, .>.7fu;qrniO 371. Investing Capital in Side Lines As has been remarked, the managers ot a corporation that has proved successful are seldom willing to stop. They wish to go 944 CORPORATE FINANCE [Bk. II- ahead and enlarge their profits. This statement applies notably to the business men of the United States. In England and other countries, business customs favor building up a sound business and maintaining it rather than restlessly pushing into other fields. No doubt the American practice makes for progressiveness, yet it also involves a constantly recurring danger of disaster. The number of companies which have taken on "side line" enterprises to their sorrow is far beyond what would usually be supposed. A conspicuous example is the American Locomo- tive Company which some years ago decided to engage in the business of manufacturing automobiles. The plant was poorly located and it is to be presumed that the officers had neither the time nor the special training which would have enabled them to handle this business with success. A few years later internal dissension in the company brought to light the fact that over $2,300,000 had been lost in a single year in the automobile enterprise. Subsequently the directors decided to accept their loss, dispose of the plant and other assets, and close all their activities in this field. In 1914 the American Water Works and Guarantee Company became financially embarrassed. This company had been a highly successful promoter of public utility corporations and of holding companies operating in the public utility field. After having succeeded in this line, it attempted to carry out certain irrigation projects and invested in these projects more than $10,000,000. In addition it eventually became necessary for the company to indorse more than $23,000,000 of the obligations of its irrigation subsidiaries. The result was that this "side line" became the most important activity of the company and was the direct cause of its difficulties, which resulted in the reorganiza- tion of the company as the American Water Works and Electric Company. No dividend has ever been paid on the common stock of the new company. On the other hand, it is sometimes true that a "side line" may prove to be the only really profitable feature of a business. Ch. 34] EXPANSION 945 For example, the London Underground Electric Railways Com- pany some years ago since had investments of a nominal value of 17,000,000, of which 15,500,000 was in the various under- ground railway companies, and 1,500,000 was in the London General Omnibus Company. The profits from the underground railways were a trifle over i%, or about 160,800; the profits of the omnibus service were nearly 23%, or about 377,000. Some of the great meat-packing concerns such as Armour, Swift, and Morris, started a great many years ago to operate refrigerator cars primarily for transporting their own products. As a "side line" they began to run these cars for the benefit of producers of fruit and vegetables, with the result, as is well known, that operating car lines became, in time, one of the most profitable features of their business. Other lines were also added. In the same way the United Fruit Company was originally designed merely to market tropical fruits, especially bananas. In the course of time, however, the company has taken over one "side line" after another, until at present it conducts banana plantations, sugar plantations, railroads, tramways, steam- ships, and refrigerator car lines. It is understood that these developments have proved profitable and that the company's revenue from its transportation interests is almost as great as from its original field of operation. On the other hand, the recent unhappy experiences of the United Retail Stores Corporation with its side lines has already been referred to. Another somewhat similar experience is referred to briefly in the report of Armour and Company for the year 1921, which in explanation of the net loss for that year of over $31,700,000, says: The year just passed was the most disastrous in our business history, as well as in the packing industry in general. A business such as ours must carry many millions of pounds of products in process of cure. Price declines, therefore, mean losses not only in sales but in inventory values as well. Extent of these losses can be visualized in price fluctuation of live hogs, which fell from a 14- 946 CORPORATE FINANCE [Bk. II- cent level at the beginning of the year to a 7-cent level at the end. Our principal losses for the year were incurred in fields of enterprise other than the meat lines. In normal times distribution of risks through further process- ing of by-products, cotton oil products, &c., is a safeguard, but last year it increased our losses because after-war liquidation was more in most of these lines of business than in our main business. Armour Fertilizer Works, third largest in the industry, suffered in common with the whole fertilizer industry and lost $8,250,000. Canned fruit and vegetable business lost heavily. Our agreement with the Government compelled us to take not merely market losses on these products, but additional losses from forced sales to liqui- date within prescribed limits. Big losses resulted from the situa- tion in the tanning business. 372. Results of Side Line Investment Perhaps the most definite conclusion that can be reached here is that the creation of "side lines" is a dangerous business policy. It involves a diversion of capital, of thought, and of creative energy that would otherwise go into building up the company's own business. This is especially the case when a "side line" is taken on, that has no vital or necessary connection with the original and proper business of the company. In that case, it calls for an especially heavy drain on the talent and resources of the company. The "side line" that develops naturally and al- most unavoidably is of a different type. It may be considered as rather in the nature of an extension than a "side line." Even when a "side line" is successful, the question still re- mains whether the application of an equal amount of capital and of managerial ability to the company's own product would not have brought still greater success. Certain it is that those companies which have achieved the greatest records of growth are those which, like the Ford Motor Company, the National Cash Register Company, the Curtis Publishing Company, and thousands of others, have devoted themselves exclusively to turning out one or two cognate products and have never allowed money or energy to be diverted from this main purpose. CHAPTER XXXV FINANCIAL STANDARDS 373- Need for Standards A man who keeps all his property in the form of cash and government bonds has, as to this, but little to worry or think about; but on the other hand he is not using his resources pro- ductively. As the same man proceeds with the development of some business enterprise, he puts more and more of his capital into the various forms of tangible and intangible assets which are required for the up-building of the business. Presently, if he is not careful, he may find himself short of cash and unable to meet his obligations, although he may be earning good profits. The same tendency is present everywhere. The executives who are managing the financial affairs of a company cannot make the business profitable merely by piling up cash resources. They must be prepared to venture out into the main current of business affairs along with their associates. And as they ven- ture farther and farther, the danger increases that their finan- cial craft may be swept out of their control. It requires constant watchfulness and sound knowledge to steer a middle course between excessive caution on the one side, and rashness in financial management on the other. It would be far easier to keep to this middle course if the safe channels were more clearly marked out. A manufacturer, for example, takes on a greatly enlarged volume of business with the result that his working capital is much reduced; he finds it difficult to determine with any accuracy whether this reduc- tion is approaching the danger point or not; he has no definite rule or standard by which to guide his course, 947 948 CORPORATE FINANCE [Bk. II- 374. Establishing Standards Many such standards of operating and financial practice are established for particular industries by general consent. These standards are in many cases of doubtful correctness, but they serve to assist those who are forming and testing policies. For example, the percentage of cost of carrying on various lines of retail business, in comparison with the gross sales of the business, has been studied. It is generally said that the cost of conducting a retail book store is about 30% of the gross sales. Again, in many lines of manufacturing the percentages of prime cost, of overhead, and of selling cost, to the prices of the articles manu- factured, are quite definitely agreed upon. Unfortunately, general standards of financial practice are not worked out in any detail or with any approach to accuracy. At this stage it would be impracticable for any individual or private enterprise to attempt to collect and collate all the data required to make our knowledge of standards of safe financial practice more complete and more practical. This is work to be done by associations of business men which have authority or can secure permission to inspect the private records of thousands of busi- ness concerns. Thus the American Bankers' Association, the Investment Bankers' Association, the United States Chamber of Commerce, and other bodies might properly co-operate in carrying through to completion investigations of this character. Such a fixing of standards might well justify governmental atten- tion. The result of such a work would be a definite determination of many standards which would be of the highest value to business executives, to bankers and other creditors, and to the whole business community in reducing the amount and seriousness of losses due to errors in handling financial problems. It would not, of course, be feasible to establish inflexible rules that would be binding alike on all classes of business. There would be ample room left for individual knowledge, foresight, and discretion. The result would be simply to establish certain normal or typical ch. 35] FINANCIAL STANDARDS 949 relations, such as cash resources in relation to current liabilities, total current assets to current liabilities, working capital to total capital, working capital to volume of business, the operating ratio, the relation of gross profit to sales, turnover, the relation of net profits to fixed and to contingent charges, of capital stock and of bond issues to gross volume of business, and so on. Hav- ing these standards in mind, the financial manager would diverge from them in his own practice only after careful consideration and with the full knowledge that he would have to convince his associates and his bankers of the soundness of his reasons. There would be little danger, as at present, of his taking chances in mere recklessness or ignorance. In the absence of a lengthy and thorough investigation by associations of business men along the lines above suggested, it is as yet impossible to do more than offer a few suggestions based upon studies of published income statements and balance sheets. These suggestions are obviously fragmentary, and are subject to the corrections and explanations that would doubtless be discovered in many cases through a detailed study of the accounts that form the basis of the published statements. The purpose of presenting these suggestions is chiefly to indicate more defin- itely how the executive may test the soundness of the practice of his own company by making comparisons with similar com- panies. These informal tests, however inaccurate and incon- clusive they may be, are often found to be a fertile source of suggestions. 375. Relation of Working Capital to Total Capital Following are the percentages of working capital to total capital as shown in the published balance sheets of a considerable number of prominent American industrial corporations, which have been selected practically at random. The figures given are those of the period immediately preceding the Great War, the enormous inflation of the war period rendering present figures too erratic to afford any basis of comparison. As a matter of 950 CORPORATE FINANCE [Bk. II- interest, however, the present-day figures are given in parentheses immediately following the prewar figures. They show startling increases in the amount of working capital involved. A large part of this working capital was tied up in the enormous and high-priced inventories carried by all the larger corporations towards the end of the war period an inventory condition out of which they are now painfully working to more normal and safer levels. 1 For convenience these companies are divided into three groups on the basis of their prewar percentages of working capi- tal, those having a proportion of working capital below 15% of total capital being placed in the first group, those having between 15% and 35% in the second group, and those having above 35% in the third group. PERCENTAGE OF WORKING CAPITAL TO TOTAL CAPITAL I Mexican Petroleum Company 3-5% California Petroleum Company 3.9 ( 6.4%) Sloss-Sheffield Company 6.1 (10.6) Corn Products Company 6.7 (30.2) Pittsburg Coal Company 8.9 (27.5) United Fruit Company 9.0 (28.2) * Union Bag and Paper Company 9.4 (25.6) Harbison-Walker Refractories Company 10.0 (17.2) American Can Company 11.5 (30.2) Railway Steel Spring Company , 13.0 (48.0) International Paper Company 14.4 (51.7) II Sears-Roebuck Company I 5- I % (69.1%) Butterick Company 15.6 (14-6) The National Enameling and Stamping Company 15.7 (38.5) United States Food Products Corporation 16.0 (17.7)** United States Steel Corporation 16.2 (38.3) Pressed Steel Car Company 18.3 (32.8) Bethlehem Steel Company 19.4 (5i.8)f * Does not include current stock distribution. ** Name changed in 1919 from Distillers Securities Company, t Including $30,000,000 of 5-year notes. 1 For inventory losses of important companies, see 381. Ch. 35] FINANCIAL STANDARDS 951 The B. F. Goodrich Company iQ-7% (5-%) Republic Iron and Steel Company 20.2 (37.4) May Department Stores 20.7 (55.8) New York Air Brake Company 21.0 (13.7) American Steel Foundry Company 21.3 (46.3) Loose-Wiles Company 21.8 (39.3) National Biscuit Company 22.3 (30.4) Lackawanna Steel Company 24.4 (40.1) Baldwin Locomotive Company 28.1 (61.9) III Studebaker Company 35-5% (34-%) Crex Carpet Company 36.8 (59.9) Armour and Company 37.0 (68.0) American Woolen Company ..,....., r . 37.4 (77.2) American Cotton Oil Company 37.7 (34.5) American Sugar Refining Company 39.6 (57.9) American Tobacco Company 42.8 (53.3) Underwood Typewriter Company 43.2 (74.9) General Motors Company 45.0 (45.8) Central Leather Company ' '.' :'/. . . 48.6 (62.0) Packard Motor Car Company. 51.0 (102.1) Swift and Company 51.0 (84.0) Morris and Company 53.0 (46.6) Eastman Kodak Company v 57.0 (190.5) Deere and Company 70.0 (64. 2) International Harvester Company 81.3 (103.4) 376. Comparison of Working Capitals It is interesting to observe that, with one or two striking exceptions, companies which are competitive or which do the same general class of business had approximately the same re- lations of working to total capital. Note, for example, the close correspondence between the California Petroleum Company and the Mexican Petroleum Company. The only other com- pany in the list which is engaged in the extraction of raw ma- terials is the Pittsburg Coal Company, which also had a low percentage. Extractive companies have little need for large inventories, stocks of raw material, or other working assets, except cash and accounts receivable. And their accounts re- ceivable do not run for long periods. 952 CORPORATE FINANCE [Bk. II- The International Paper Company and the Union Bag and Paper Company are both in Group I; doubtless, owing to the fact that both companies manufacture from wood pulp, which is supplied by their own forests, they had little occasion to carry heavy stocks of raw materials or inventories of half-finished products. The American Can Company, the Corn Products Company, the Sloss-Shemeld Company, and the Harbison- Walker Refractories Company, seem-, on the face of the above showing, to have working capital considerably below normal. It is likely, however, that a more thorough examination would reveal reasons which are not now apparent. All these com- panies show considerable increases in working capital for the postwar period. The United Fruit Company is, to a large extent, engaged in transportation rather than in producing and selling. As has been previously pointed out, transportation operations do not call for large amounts of working capital. The various railway equipment companies, including the Railway Steel Spring Company in Group I and the Baldwin Locomotive Company, the New York Air Brake Company, and the Pressed Steel Car Company appearing in Group II, all had a low proportion of working capital compared with other indus- trial companies. It may be. assumed that in railway equipment manufacturing, comparatively little money is tied up in accounts receivable. All the steel manufacturing companies, including the Ameri- can Steel Foundry, the Bethlehem Steel Company, the Cambria Steel Company, the Lackawanna Steel Company, and the United States Steel, are included in the second division, and all had working capital proportions below the average. We may again observe here, as in the case of the paper manufacturing companies, that "integrated" production (that is to say, unified control of a complete series of operations from extracting the raw material to delivering the finished product) favors a low pro- portion of working capital, as the necessity for carrying stocks of raw materials is much reduced. Ch. 35] FINANCIAL STANDARDS 953 The two biscuit manufacturing companies Loose- Wiles and the National Biscuit Company were approximately equal in respect to proportions of working capital. The other companies in Group II call for no special mention. In Group III are included a number of important companies which may be subdivided into two classes: those which find it necessary to carry large inventories of materials, goods in pro- cess, and finished goods, and those which find it necessary to sell on an instalment or long-term basis, so that accounts receivable are always heavy. The first-mentioned class includes Ameri- can Sugar Refining Company, American Tobacco Company, American Woolen Company, Central Leather Company (the length of period of leather manufacture is exceptionally long), Crex Carpet Company, American Cotton Oil Company, and Eastman Kodak Company. Some of the companies just men- tioned also carry unusually large sums of cash. The two agricultural implement companies in this group, International Harvester Company, and Deere and Company, as well as the Underwood Typewriter Company, belong in the class which sell their products on long terms. Under the strict definition of the term, we should probably not allow the agricul- tural companies so large a proportion of working capital ; for in arriving at this figure all accounts receivable have been listed under "current assets." These accounts, however, consist in large part of small notes running for one, two, and three years, and are hardly to be described, therefore, as "current." If we were to include only accounts maturing within three months, or even six months, our figures for working capital of these com- panies would probably show them in about the same condition as other industrial corporations. The automobile companies, Studebaker, General Motors, and Packard, like other manufacturers of automobiles, carry large stocks on hand, especially at certain seasons of the year. So long as this practice remains a necessary feature of the business, they will be required to carry large proportions of working capital. 954 CORPORATE FINANCE [Bk. II- The meat-packing companies Morris, Swift, and Armour find it necessary to carry large inventories of live-stock and of goods in process. On the whole, in running over the list that has just been given and in examining large numbers of other industrial balance sheets, it becomes fairly evident that well-managed business enterprises customarily follow standards that are more or less similar and that lead them to establish similar proportions of working to total capital. The exceptional cases, both above and below the normal proportions, are for the most part readily explainable. Each financial manager, taking the published statements of the firms that are most nearly like his own, will find it useful to make a comparison and, if possible, explain the striking divergences either above or below the average. 377. Cash and Cash Resources Closely related standards and tests apply to the proportions of cash and resources immediately convertible into cash (prin- cipally securities held for sale) to gross volume of business, and to current liabilities. Inasmuch as banks are devoted almost exclusively to hand- ling cash and credit, we should naturally expect that their practice in respect to these factors would be more definitely standardized than the practice of mercantile manufacturing companies, and this is actually the case. The experience of financiers over many generations has gradually crystallized into the conclusion that in an ordinary commercial bank, which is effectively using most of its capital in its own business, that capital ought to be invested chiefly or wholly in cash, or at least in cash and secondary reserves immediately convertible into cash. The proportion of cash to demand liabilities has been fixed by long experience at from 15% to 25%. In most American industrial companies, the proportion of average cash to gross sales is about 3% to 6%. If the company is paying its bills promptly and is not overborrowing, current Ch. 35] FINANCIAL STANDARDS 955 liabilities should not exceed 20% to 30% of annual sales. This refers, of course, to the business of manufacturing a standard article or articles which can be sold in fairly steady volume. On the basis of these figures, cash and cash resources should be about 12% to 25% of current liabilities, and this is not far from the customary showing. 378. Turnover The definition of the term and the reasons for laying great importance upon quick turnover have previously been dis- cussed. 2 The additional point that belongs in this chapter is a statement as to the ratio of turnover which may be accepted as standard in various lines of business. This statement is by no means complete or conclusive, but is based upon the frag- mentary information which it is now possible to obtain from the records of business firms. A cotton goods commission house which does a little financing of sales, employs some traveling salesmen, and carries rio stock, has total working assets of $400,000. The annual sales of this house are about $3,500,000, showing a turnover of nearly 900%. This is regarded as a good, though not abnormal, showing. A large department store is said to carry an average stock of $8,000,000 to $10,000,000, and to have average sales of $15,- 000,000 to $20,000,000, showing a turnover of 200%. It is said, on excellent authority, that many retail grocers make a complete turnover at least once a month, equivalent to 1,200% for the year, while country stores, which are forced to carry a large assortment of stock, are well satisfied to do 300% to 400%. One small retail store is recently reported to have done 900%, but this is an extraordinary showing. In manufacturing companies, turnover is an element of so much less importance relatively, that comparatively little atten- tion has been paid to attempting to determine standards. It would be unsafe to rely on published balance sheets and income 1 See fi 150-154. 956 CORPORATE FINANCE [Bk. II- statements as the sole source of information in figuring turnover, inasmuch as the working capital of most concerns varies consid- erably from one season of the year to another and a comparatively slight variation would make a large difference in the results of the calculation. 379' Operating Ratios One of the most important standards or tests of efficiency in all lines of business is the percentage of total expense of run- ning the business, including manufacturing, selling, and admin- istrations, to the gross sales more commonly known as the "operating ratio." It is clear that the difference between 100% which represents gross sales and the operating ratio is the per- centage of profit on sales. The lower this percentage of profit or, in other words, the higher the operating ratio the more unstable, other things being equal, is the business as a money maker; for a high operating ratio means that even a slight varia- tion in the expenses which comprise it may be sufficient to trans- form a profit into a loss. On the other hand, a phenomenally low operating ratio indicates a business which is earning excessive profits and is therefore peculiarly subject to competitive attack. The oper- ating ratio should always be compared with the capital invest- ment and the fixed charges of the business, which should not, however, be included in calculating the ratio. Although the operating ratio may be regarded as not primarily a financial factor, and certainly is but partially subject to control by the financial management of the company, yet it is an element of so much importance that it requires careful consideration both by the operating officials and by those who are primarily inter- ested in accounting and finance. The term "operating ratio" was first applied, and is still most generally used, in connection with steam railroads. The ratio here is low, usually not more than 70%; sometimes it climbs to 80% and 90% or even more, and sometimes falls as low as 55%. Ch. 35] FINANCIAL STANDARDS 957 The operating ratio of the Chicago, Rock Island and Pacific Railway for the last ten years is as follows: 1911 72.80% 1916 1912 1913 1914 1915 72.33 74-94 76.15 75-19 1917 1918 1919 1920 68.10% 73-70 85-87 87.03 94.07 380. Percentage of Profit When we come to industrial and mercantile businesses, the same result is perhaps better attained by taking at once the per- centage of profit on gross sales. The gross sales, net profits, and percentage of profits on gross sales are given below for three typical concerns. All these have a fair margin of profit. As will be noticed, the percentage is very stable in each case. GENERAL ELECTRIC COMPANY Gross Sales 1914 1915 1916 1917 1918 1919 1920 $ 90,467,693 85,552,070 134,242,200 196,926,318 216,815,278 229,979,983 275,758,438 Net Prpfits $ 8,970,964 8,623,887 15,294,091 29,004,540 28,375,756 33,124,300 26,460,058 Percentage 9-9 10. 1 11.4 14.7 13-1 14.4 9.6* F. W. WOOLWORTH COMPANY Gross Sales 1914 $69,619,669 1915 75,995,774 1916 87,089,271 1917 98,102,857 1918 107,179,411 1919 119,496,107 1920 140,918,981 NEW YORK TELEPHONE COMPANY Receipts 1916 $57,005,565 1917 62,961,006 1918 66,691,095 1919 75,065,893 1920 87,906,465 * $17,800,785 written off inventory in 1920. Net Profits Percentage $6,429,896 9.2 7,548,210 9-9 8,713,445 10.0 9,252,349 9-4 7,088,716 6.6 10,361,557 8.6 9,775,252 6.9 Net Profits Percentage $15,002,260 u>U 26.3 14,293,333 22.7 I2.4Z9.887 18.6 12,966,125 17.2 5,483,026 6.2 958 CORPORATE FINANCE [Bk. II- Percentages for other businesses might be given ad infinitum, but it would be useless to go farther here than to indicate roughly some of the considerations which enter into determining a satis- factory operating margin for any one business. As already indicated, a company which requires a large amount of fixed capital and which has therefore heavy fixed charges, but light operating expenses, should normally have a small operating ratio, as is the case with the New York Tele- phone Company. Normally, a manufacturing concern will have a margin of profit not far from 10%, as shown by the General Electric Com- pany. Trading companies, such as the F. W. Woolworth Com- pany, run about the same. The man who is thoroughly familiar with a given line of business and who knows with some definiteness the normal per- centage of profit that, is required in order to make the business safe and profitable, will not fail ordinarily to look to the operating ratio as his first significant test of any company's financial status. 381. Inventory Statistics In this general connection the following tabulation showing the inventories carried by some of the large corporations, and the effect upon them of the conditions following the war, will be found of interest. 3 It is the 1921 balance sheets that tell the story of the reaction following the war tune prosperity. Inventory accounts mirror the savage cut to even below prewar values for many commodities. What appeared to be huge profits built up during war prosperity have in many cases turned out to be but inflated inventory values and these have been punctured by the fall in prices of both raw and finished products during 1921. To absorb these losses with sales running far below normal has been the problem. Twenty-three representative concerns show a combined inven- tory account of $715,091,762, against $1,199,330,639 a year ago, or a decline of 43%. For the prewar year 1914 these same con- From Wall Street Journal, March 10, 1922. Ch. 35] FINANCIAL STANDARDS 959 cerns had a combined inventory of $363,147,150, or approximately one-half the present value. In this connection it should be remem- bered that many companies have expanded their plants since 1914 and would naturally be expected to carry a larger supply of materials. The following table lists 23 of the larger industrial concerns which have reported for 1921 and compares the 1921 inventory account with that of 1920 and the prewar year 1914: Inventory account: 1921 1920 1914 American Hide & Leather .$ 5,886,096 $ 9,289,186 $ 9,629,441 American Sugar 12,206,239 45,45,i55 15,431,099 Armour 83,320,641 136,723,528 44,672,448 American Locomotive .... 4,350,200 8,284,211 3,962,810 Baldwin Locomotive 7,000,736 20,182,280 4,029,367 Bethlehem Steel 41,115,700 73,208,678 11,130,734 Central Leather. 48,403,924 60,586,898 42,645,904 Cudahy 17,177,704 30,648,35? 14,079,201 Cuban-American Sugar. .. 12,901,714 15,593,934 3,966,453 B. F. Goodrich 29,618,936 72,631,058 11,308,857 General Motors 108,762,625 164,684,679 11,642,370 Kelly-Springfield 5,5 2 5,730 9,751,388 i, 795,365 Loose-Wiles 2,936,848 5,230,811 1,981,136 Lackawanna 13,304,041 17,723,923 9,139,674 Midvale 36,319,212 45,393,835 33,422,686 Montgomery Ward 16,767,592 30,282,672 6,780,822 Morris & Co 21,548,259 ' 30,624,016 19,297,166 National Biscuit 3,595,327 8,235,341 5,280,844 Fierce-Arrow 11,246,697 16,470,662 *9,68o,os7 Sears-Roebuck 46,445,880 105,071,243 13,273,927 Swift & Co 93,771,464 151,305,085 45,899,008 U. S. Rubber 76,691,777 123,503,031 33,606,741 F. W. Woolworth & Co. . . 16,194,461 18,500,668 10,491,040 *!9i6. Total $715,091,762 $1,199,330,639 $363,147,150 rf bluotte oJ CHAPTER XXXVI ANALYSIS BASED ON FINANCIAL STANDARDS 382. A Problem in Finance Bankers, credit men, investors, and others who are not in- timately acquainted with a given business, are frequently called upon to form tentative judgments as to the financial efficiency of a business, based chiefly upon statements of account that are furnished to them, or even upon a few unconnected figures. The process of piecing together these fragments and from them forming a fairly definite mental picture of the status and efficiency of the concern, is not unlike the work of those scientists who from a few small bones are able to reconstruct the skeleton of some prehistoric animal. In making an analysis and "reconstruction" of this kind, financial standards, if available, which apply to the business under consideration are of much value. The following problems from the general manager of a whole- sale house call for opinions on certain questions of finance : The firm has a paid-in capital of $125,000, having been in business three years with an approximate surplus of $25,000. Of this capital, $35,000 is invested in a store building, warehouses, furniture, drays, and general equipment necessary for the carrying on of said business. We have approximately $90,000 stock and the surplus is working capital. The credit of the firm is $25,000 to $200,000 high credit. 1. What is the average stock of merchandise the business referred to should have at all times? 2. What maximum open accounts would be conservative for this business to carry? Goods sold at 60 days' time, 75% of the business sold to merchants with good credit, 25% of the business retail, principally city accounts collected on first of each month after purchase. of- Ch. 36] FINANCIAL STANDARDS 961 3. What maximum amount of bills payable should our books show for borrowed money, goods, etc.? 4. What amount in bills receivable would be conservative at any one time? 5. What would be the maximum amount of yearly business such a firm should do for capital invested? '? v 6. W r hat amount of dividends should stockholders be paid, the average net earnings of the firm being 25%, after all expenses and losses are paid and accounted for? 383. Analysis of Problem On the basis of this somewhat scanty information, the reply sent was, in effect, as follows: From the information given, a highly condensed balance sheet of your business would read somewhat as follows: Assets Building, Furniture, and Equipment $ 3S,ooo Stock 90,000 Working Capital 25,000 Total Assets $150,000 Liabilities Capital $125,000 Surplus 25,000 Total Liabilities $150,000 The $25,000 working capital must consist partly of cash and partly of an excess of accounts receivable over accounts and other obligations payable. In order to prepare an opinion that would fit your case, the following additional information is essential and should be sup- plied: Normal amount of cash in bank. Normal amount of accounts and bills payable. Normal amount of accounts and bills receivable. Average percentage of gross profits. Average operating expenses per moutV 962 CORPORATE FINANCE [Bk. II As these facts are not furnished, the following assumptions are made: Normal Cash Balance $10,000 Normal Accounts and Bills Receivable 90,000 Normal Accounts and Bills Payable 75 ( ooo Average Operating Expenses per month 15,000 Average Gross Profits (on selling prices) 25% Very likely these assumptions are a long distance from the facts. That, however, will not affect the reasoning; you can readily fill in the right amounts and thus make the figures suit your situation. With these assumptions, your balance sheet would read as follows: Assets Building and Equipment $ 35,ooo Stock . 90,000 Accounts Receivable 90,000 Cash v 10,000 Total Assets $225,000 Liabilities Capital $125,000 Surplus 25,000 Accounts Payable 75iOoo Total Liabilities $225,000 The above balance sheet on its face would seem to indicate a fairly strong financial position. Your quick liabilities would be only 75% of your quick assets, not counting stock most of which is no doubt readily salable. This percentage in mercantile com- panies and in those manufacturing companies that carry large in- ventories of finished products is generally considered conservative. The percentage in emergencies or at certain seasons of the year might rise as high as 85% or even 90% without indicating reckless- ness, but this high ratio should be short-lived. Another ratio to consider is that between quick liabilities and the total of current assets, including stock. It is safe to say that this percentage should not normally be higher than 50%. The" balance sheets for a period of years of a large wholesale dry goods company showed a ratio of quick liabilities to total quick assets at the end of each fiscal year as follows: 40%, 55%, 40%, 57%, 45%, 40%, 38%. In the above assumed balance sheet, the total Ch. 36] FINANCIAL STANDARDS 963 of current assets is $190,000, and of quick liabilities, $75,000, or less than 40%. This is conservative enough. Buyers of commercial paper, especially large banks, sometimes make an arbitrary requirement for a definite ratio. In Babson and May's treatise on "Commercial Paper" the following rule is laid down: "Two and a quarter of quick assets, that is, assets which can be converted readily into cash, to one of debts, have been taken as a fair showing to be called for on an annual statement .... The ratio of 2%. to i should be regarded as a fair ratio to be expected on the statement of the average mercantile company, and most borrowers of this class in the open market, under our present sys- tem of commercial paper, ought to show this much." Going back to the hypothetical balance sheet, it is obvious that the gross volume of business which can be carried on with safety is to be determined only by a study of the proper relations of the various assets and liabilities to each other. To illustrate: make the assumption (which is, of course, out of the question) that the gross sales in the month following the date of the above balance sheet should amount to $100,000. What would be the effect on the business? First, goods of a cost value of $75,000 would have been sold and would have to be replaced. In addition, with this volume of business, the stock on hand would obviously have to be increased to say $125,000. This would make it necessary to buy during the month $110,000. Assume that $50,000 of the $90,000 accounts receivable fall due during the month and that $40,000 of the accounts payable become due, then the cash receipts would be $50,000 (assuming that there are no cash sales), $15,000 of which would go for operating expenses, leaving $35,000 to apply toward the accounts payable; it would be necessary in addition to draw $5,000 from the cash on hand. We must, of course, assume that such a volume of business would require an increase in equipment which we may assume to amount to $5,000. The condensed balance sheet at the end of the month would then be as follows: iii ^nip.jfij i >". -.ti 1.0 11 .:) i, Jijo vq oJ rxpiq Assets 7I." $ 40,000 Stock 125,000 Accounts Receivable. . . . . ,,..^. f[ ;, M r-rff*ftfW I4 ' 000 rm :'. ;V,i/> :/!<.. Total Assets.' ...."..,. $305,000 .Ifiliqm gnmov/ '\UQ/ 964 CORPORATE FINANCE [Bk. II Liabilities Capital $125,000 Surplus 35,ooo Accounts Payable 145,000 Total Liabilities .................................. $305,000 ' il'iifl'.v hJ x*n ..-:! J '>i.';j> k> iitfieup B-J^ Evidently this would be an impossible situation. It appears absurd enough when put in this exaggerated form; yet business concerns frequently work themselves into a situation somewhat like this by trying to carry a volume of business which is far beyond their capital. With no more facts than you have given and with only the above assumptions to work on, it is not possible to give an intelli- gent answer to your questions as to the amount of yearly business a firm of your size should do. Probably something like $500,000 a year, $40,000 a month would be somewhere near normal, though it is unsafe to name that or any other figure without knowing more about the situation. Your first question as to the average stock of merchandise can be answered only with relation to your fifth question as to the maximum amount of yearly business. Your stock must be pro- portioned to the volume of your sales. Your sales must be pro- portioned to the equipment and working capital of your business. It is not possible to answer your questions 2,3, and 4 by giving definite figures, for the reason that the right amounts of receivables and payables are determined by the relations of these items to each other and to the other assets and liabilities of the business. The attempt has been made to indicate above what are generally con- sidered the right percentages; and also to indicate the line of reasoning to be followed in passing judgment on any particular business, all the essential facts being available. In a mercantile business that is running on a sound basis and that is not increasing its volume of sales too rapidly, it is considered proper to pay out a fairly large proportion of its net earnings in dividends. If your net earnings are 25% and the volume of your sales is some place near the maximum, a dividend of 15%, or pos- sibly even a little more, would not be out of place. The case is entirely different if your business is growing rapidly. In that case it is obviously necessary to reserve more cash and thus build up your working capital. Ch. 36] FINANCIAL STANDARDS 965 384. Checking up the Analysis In acknowledging the analysis just given, the manager of the business under consideration makes the following comment: I notice in your report that cash balance and normal accounts and bills receivable should be approximately $100,000. To show how near you came to the actual facts, our recent trial balance showed in April $96,000 covering these two accounts, approxi- mately $10,000 cash balance. Our liabilities at times will run some- thing near $75,000, though at present they do not show this much. The only figures I have reason to challenge in your report would be your expense account of $15,000 per month. You no doubt have in view the handling of some very profitable line of goods. Our expense account showed in proportion to the sales io>2%, approxi- mately $40,000 per year. Your idea that a firm of our capital should do $500,000 agrees with my own. In other words, a whole- sale firm should, at least, turn its capital stock four times during its fiscal year. From the above it seems clear that through the proper use of accepted standards of financial practice it is possible to arrive at a fairly accurate understanding of the status of a concern even when the information available is limited, ID . j/.J; to ol a-Gf Part VI Financial Abuses and Involvements yrti CHAPTER XXXVII EXPLOITATION BY OFFICERS :oqrr 385. Exploitation Any gross deception or breach of trust which operates to the injury of an innocent party is fraud, and is recognized in law as sufficient cause for invalidating a contract or for bringing action to recover damages. Under certain conditions it may constitute a crime. It is often difficult to prove fraud in a transaction, since evidence is usually required of an intent to defraud or mislead. Exploitation differs from simple fraud in that it is more subtle, more difficult to trace and expose, and ordinarily gives no grounds for legal action. There is no one act or set of acts that can be listed and definitely described as exploitation, since it takes an infinite number of forms and in many cases is not known or recognized even by its victims. Nor is there absolute certainty, ordinarily, that a company has been deliberately exploited, even though it may have been wrecked and the facts of its mismanagement may have become known. It may be proved that those in charge of the company's affairs have secured personal profits and that the transactions have been injurious to the company. Yet the plea may always be made by such persons that mistakes of business judgment are common to all enterprises and that this is a case of the kind. Frequently such pleas are sound and the criticisms made by stockholders of losing corporations are unjustified. There is no definite standard or simple rule which can be applied here. The 967 968 CORPORATE FINANCE [Bk. II- facts as to every case where exploitation is suspected require careful study, and even then the judgment of observers fre- quently has to be based more upon probabilities than upon definite facts. In general, exploitation may be said to differ from fraud in that, while the intended results are practically the same, there is always room, in case of exploitation, for varying interpretations of the facts. Exploitation is dangerous because it may be so easily dis- guised. Plausible arguments in favor of almost any business proposition can be advanced so easily that it is seldom possible to arouse unanimous opinion and action against practices that savor of exploitation. Again and again it has been proved that in large enterprises comparatively few stockholders will vigor- ously support action intended to recover funds that have been lost by exploitation. Consequently, we often see the surprising spectacle of corporations being obviously mismanaged and deliberately exploited while the management is receiving the loyal support of the very stockholders whose property it is looting. Usually it is only when the exploiters become over- bold, and take some action verging on actual fraud, that the injured stockholders appoint committees from their number and take effective legal steps to put a stop to the management's depredations. .aini/3iv ii v/f nova ba: <> rrwon>[ 386. Exploitation Favored by the Corporate Form There always has been, and doubtless will continue to be, exploitation by the powerful and influential of those who are weak and helpless. But exploitation in its modern and now most prevalent form, as a factor in business life, is comparatively a new thing, largely due to the general adoption of the corporate form of organizing business enterprises. The corporate form is singularly well adapted for exploiting activities. Through the creation of a small corporation, an individual may wholly or partially hide his own identity and rid himself of personal re- sponsibility. Again the large corporation with its thousands or Ch. 37] EXPLOITATION BY OFFICERS 969 tens of thousands of shareholders, few of whom know much about or take a personal interest in the fortunes of their corporation, offers an inviting opportunity for exploitation. The legal fiction of "corporate entity" which has been more rigorously upheld and applied in American courts than in English courts, has undoubtedly been a highly important factor in favor- ing exploitation. Again and again, the wrecking of great cor- porate enterprises by those in charge furnishes ample evidence that human nature is still weak. The law is slow. The wreck- ing of the Erie Railroad in the last century was accomplished by methods not illegal then, but that now might put those that used them in the penitentiary. But the exploiter of today employs no such crude methods. He has kept ahead of the law. 387. Abuse of Official Position It is seldom that the chief officers of an important modern corporation are suspected of betraying their trust. Recently, however, the Bar Association of New York City brought dis- barment proceedings against a former attorney of the Missouri Pacific Railway, charging him, while counsel for that company, with aiding and abetting its president in the diversion of funds from the company's treasury. As reported in the New York Times: * According to the Bar Association charges, the Missouri Pacific transaction in which Mr. Chadbourne is alleged to have been in- volved as counsel for President Gould and the road dealt with the sale of about $19,000,000 worth of bonds, and the diversion of almost $5,000,000 from the road to Mr. Gould and others. The transaction took place not long before Mr. Gould was ousted from control of the road by Kuhn, Loeb & Co., the road's bankers. The Bar Association version of the transaction was explained by a member of the Grievance Committee yesterday as follows: "Tailer & Co., investment bankers, of which T. Suffern Tailer is a member, were asked to lend money to the Missouri Pacific. They were to take certain nqtes of the Missouri Pacific and as col- i March 7, 1922. 970 CORPORATE FINANCE [Bk. II- latcral were offered an option on $19,000,000 bonds of a subsidiary road at 81. Gould did not take the notes he had agreed to take, and Tailer & Co. sold them for him to other parties, and most of his rights to take up those bonds at 81 disappeared. "When he found out that Kuhn, Loeb & Co. offered to re- organize the road but insisted that the road must have clear title to these bonds, he realized that the bonds were getting valuable, and went, through Chadbourne, to Tailer & Co. and insisted on being reinstated in the rights he had lost. Tailer agreed against his will to reinstate him. "After that, Gould purchased the $19,000,000 worth of bonds at 8-1 from the front door of the treasury of the Missouri Pacific, and sold them to Kuhn, Loeb & Co. at 102, and then they were taken around to the back door of the Missouri Pacific treasury and sold at 107. "The point of the accusation is that Mr. Chadbourne was acting as personal lawyer to George Gould and also as lawyer for the road, and that he stood by and watched the robbery of the road of which he was the lawyer." It may be stated that the accused attorney denies he was counsel for the road at the time the alleged looting occurred. 388. Abuses by Subordinate Officers In a corporation which is conducted by able business men who are single-mindedly devoted to the up-building of the cor- poration, it is probable that nearly all subordinate officers will be of the same type. In the business world, as everywhere else, like attracts like. Men who are themselves honorable prefer to work under chiefs with the same sense of honor. If they sus- pect that their company is being exploited by its officers, they will leave and their places will be taken by men who are perhaps less able or less scrupulous. There are, of course, innumerable exceptions on both sides, but the general rule holds good. Con- sequently, when we find a company in which the chief officers have been primarily engaged in exploitation, it is only too likely that graft will also be found among the subordinates. Under the old regime, the New Haven Railroad Company, Ch. 37] EXPLOITATION BY OFFICERS 971 according to the report of the Interstate Commerce Commission, purchased its rolling stock almost exclusively and without com- petition from one individual. These purchases amounted to approximately $37,000,000. The favored individual made no secret of the valuable presents made to the officials with whom he did business, claiming that they were old friends of his. The Commission makes the following pertinent comment: -"Cor- porate economy is not practicable where gifts and obligations arising from friendship tend to obscure official duty." /i%;->:j;// ->rD jioqUt. a 389. Exorbitant Salaries and Payments In a small corporation which has come into the control of one faction and is being exploited to the detriment of the general body of stockholders, the simplest and most common method is through payment of exorbitant salaries. So long as the salaries are kept within the bounds of reason and so long as the real purpose which is to distribute profits in this form is not made too plainly evident, the practice is legally unassailable. It may, however, become dangerous to the exploiters in case their salaries are suddenly increased, or in case there is a rearrangement of salaries which so clearly corresponds to shareholdings as to leave no doubt that the increases are really mere devices for distribut- ing profits to the dominant faction at the expense of the other shareholders. In the early days of the United States Shipbuilding Company, there was considerable mystery as to the failure of the company to live up to the advance estimates of its profits. Later when the company went into the hands of a receiver, it developed that one of the most important subsidiaries taken over, the Union Iron Works, had been assumed to have a surplus of $1,000,000, whereas it really had an accumulated deficit of about $1,400,000. Furthermore, Receiver Smith discovered that the Shipbuilding Company had entered into contracts to retain certain officials at salaries aggregating $240,000 per year. Most of these salaries were heavy advances over those which had previously been paid. 972 CORPORATE FINANCE [Bk. II- In its investigation of the affairs of the Rock Island Company, the Interstate Commerce Commission found that large extra and secret payments were arbitrarily allowed to some of the chief officers of the company, of which the following are examples : The first vice-president, in charge of freight and passenger traffic, was secretly paid $18,750 per annum, making his total compensation $43,750, whereas the pay-roll showed but $25,000. The chief engineer received a salary of $15,000 per annum plus a secret bonus of $3,000 on the first of each year. Upon the retirement of the general solicitor, he was given a bonus of $100,000 in cash. It is perfectly true that some of the above payments may be defended, but they at least illustrate with striking clarity the almost unlimited possibilities for abuse if a board of directors is inclined to be careless in its use of the property with which it is entrusted. 390. Contracts That Benefit Officers The history of the Standard Rope and Twine Company, which was formed in 1895 to take over the assets of the insolvent United States Cordage Company, illustrates some of the possible methods of exploiting a corporation to the personal advantage of the officers. The first president was accused whether justly or unjustly cannot be definitely determined of discriminating against the Standard Company in favor of a competing concern in which he was a partner, turning the less profitable contracts toward the former and the more profitable ones toward the latter. In 1896 the president proposed that the Standard Company should take over certain processes controlled by him for forcing oil into rope. The company made a contract which gave the president authority to spend $25,000 of the company's money in perfecting his invention. As a matter of fact, much more than this amount was eventually spent. In the end the process proved worthless and the company had to bear a heavy loss, amounting to over $126,000. Ch. 37] EXPLOITATION BY OFFICERS 973 In September, 1898, some of the officers of the Standard Rope and Twine Company formed a selling agency known as the Union Selling Company. This last-named company then entered into a contract with the Standard Rope and Twine Company under which it received yX% commission on all sales. A stockholders' committee in 1900 estimated that the effect of this contract was to increase by more than 50% the selling expenses of the Standard Company. The misuse of "construction" companies as a means by which officers may make contracts for their own advantage has been a practice unfortunately not at all uncommon. Another almost customary method of "milking" railroad corporations a genera- tion or two ago, was through the organization of "fast freight" or "despatch" lines which made particularly favorable contracts with two or more railroad companies for moving their cars on an express schedule and then picked up highly profitable quick despatch business from shippers. In a number of cases the stockholders hi these lines were the officers and directors of the railroad companies over whose tracks the lines operated. It was many years later before the railroad companies stepped in and purchased the ownership of 'these lines. Another common method of making contracts for the advan- tage of officers has been through the purchase at high prices of subsidiary or branch companies in which officers were personally interested. In 1890 the directors of the Northern Pacific who were, as individuals, also in control of the Wisconsin Central, effected a lease of the last-named road to the Northern Pacific for 999 years on terms which the stockholders' committee con- sidered unfair to the Northern Pacific. The receivers of the Northern Pacific four years later, however, were unable to obtain sufficient evidence to justify legal action against the directors. 391. Ethics of Contracts Benefiting Officers Contracts made by officers of corporations with corporations in which these officers are interested or with the officers person- 974 CORPORATE FINANCE [Bk. II- ally, may become one of the most insidious forms of exploitation. The contracts with the Standard Rope and Twine Company cited in the preceding section illustrate the dangerous possi- bilities. The difficult point here is found in the fact that fre- quently a contract with a company in which the officer letting the contract is interested, is justifiable. The temptation is, though, always present when an officer is contracting with a com- pany in which he is interested, to give better prices or better terms, or other advantages that would not be granted if the con- tract were given to an outsider. The question may come up when an officer of a corporation is interested in another corporation from which the first corpora- tion buys, or when his corporation sells to another corporation in which the officer is interested. Possibly the corporation may be able to buy better from the officer's corporation than else- where. Or possibly the corporation may be able to sell to better advantage to the officer's corporation than to others. In that case the transaction is justified. So true is this that just such contracts are specifically provided for by some of the larger corporations. Thus in the by-laws of the United States Steel Corporation occurs the following provision, expressly authoriz- ing such contracts. Sec. 8. Contracts. Inasmuch as the Directors of this Company are men of large and diversified business interests, and are likely to be connected with other corporations with which from time to time this Company must have business dealings, no contract or other transaction between this Company and any other corpora- tion shall be affected by the fact that directors of this Company are interested in, or are directors or officers of, such other corpora- tion, if, at the meeting of the board or of the committee of this Company, making, authorizing, or confirming such contract or transaction, there shall be present a quorum of directors not so in- terested; and any director individually may be a party to, or may be interested in, any contract or transaction of this Company, provided that such contract or transaction shall be approved or be ratified by the affirmative vote of at least ten directors not so interested. Ch. 37] EXPLOITATION BY OFFICERS 975 392. Avoidance of Contracts Benefiting Officials But, as has been stated, the temptation to exploitation when officers are personally interested in the award of contracts is so strong and so ever-present, that such transactions should, as far as possible, be avoided. Looking toward this end, the fol- lowing conclusions would probably be sanctioned by most busi- ness men: . i. The number of concerns which are controlled by the officers and directors of a corporation, and with which it has contracts or is otherwise intimately connected, should be re- duced to the minimum. . 2. Wherever the arrangement is unavoidable, it should not be concealed but should be clearly stated and made known to all those who are interested. 3. Whenever such a relationship exists, the contracts between the corporation and the related concern should be subject to criticism and correction by competent and disinterested parties. 4. When a new company in a related line is to be organized by the officers of a corporation, and when they are to take an active part in its development, they should leave the service of the old corporation. 393 "Unloading" and Securing Control A somewhat different case arises when the officers of a cor- poration are financially interested in another company which has proved to be a money loser, and wish to "step from under." Then if the business in which they are interested is in any way related to the business of the corporation of which they are officers, it is frequently an easy and tempting procedure to "unload" a portion of their holdings on the latter corporation or secure from it financial assistance for the failing company. The process is especially easy when they are active officers and able to work together without interference in putting through their plans, and when the other directors have little direct personal knowledge of the details of the business. Under these circum- 976 CORPORATE FINANCE [Bk. II- stances, all that is required is to make representations and recom- mendations which can hardly be challenged unless the other di- rectors wish to go to the extent of expressing lack of confidence in their own officers. Sometimes schemes of the same general type may be put through with a view to enabling the officers to secure personal control, for their own benefit, of another company in which they are financially interested. By inducing the company in which they are officers to take stock additional to their own, they may be able to acquire the desired control. 394. Misuse of Inside Information Another common method of exploitation is through the mis- use by officers or directors of information which comes to them on the "inside," that is, officially, but which is unknown to stock- holders or perhaps is unknown to some of the other officers and directors of the corporation. The use of such information is most likely to occur in connection with speculation in the company's own shares. Innumerable instances might be given of the misuse of inside information for the purpose of speculating in the shares of the officials' or directors' own company. The results are not infre- quently unfortunate for the officers themselves, due partly to the fact that the information upon which they act is in many cases fragmentary, and due also to the fact, which many people fail to realize, that the up and down movements of stock market prices are determined only in part by the intrinsic merits of the securities. Fluctuations arise more largely from general eco- nomic and market influences, with which 'the officers of most in- dustrial corporations are not especially familiar. The matter is discussed more fully in the following chapter. 395. Misuse of Funds The doubtful use of company funds by the company officials is a common form of exploitation. It usually occurs in close Ch. 37] EXPLOITATION BY OFFICERS 977 connection with the activities of the company's own business. For instance, the early history of the National Cordage Company, which has been referred to previously, was a record of wise management and success. After about three years, however, two of the important executives became interested in an attempt to bolster up the price of sisal and hemp and devoted the re- sources of the company quite largely to this speculation. "The enterprise was changed from a business to a speculation. Ex- tension of control became a mania with the officers and their ambition stifled their sound business judgment." Inasmuch as the National Cordage Company was by far the largest purchaser of the two products mentioned, it seemed as if the calculations of the officers, based upon their absolute knowledge of the com- pany's own policy, could hardly miscarry. But they did not reckon on the fact that the resources, even of so great a company, are limited, and eventually so large an amount of capital was tied up in carrying great stocks of sisal and hemp that the com- pany itself was forced into bankruptcy. ,396. Is Exploitation a Common Evil? As has been intimated at the beginning of this chapter,- exploitation as a factor in business transactions is perhaps a more common evil than it was in the days when business organizations were simpler and more directly under the control of their owners. The officer or director of the modern corporation occupies a position, not merely of dignity and responsibility, but also of trust. This trusteeship is more clearly recognized, perhaps, than was the case a generation or more ago. But the ascendency of the higher standards, which are implied in the sense of trustee- ship, comes slowly and is the result of innumerable hard struggles. In the meantime, exploitation in its myriad forms goes on apparently unchecked. The difficulty of the situation is due to the great complexity of present-day business relations and the impossibility in so many cases of arriving at clear and unquestionable decisions. Because 978 . CORPORATE FINANCE [Bk. II- of this it is not easy to say whether exploitation is becoming more or less prevalent. All that can safely be said is that the gradual clarifying of the ethical standards which apply under modern complex conditions will undoubtedly tend to diminish exploitation. >iffi CHAPTER XXXVIII EXPLOITATION BY DIRECTORS AND STOCKHOLDERS 397- Juggling the Accounts In January, 1895, J ust about a year before the failure and reorganization in 1896, the president of the Baltimore and Ohio Railroad Company issued a statement which is typical of those frequently put out by officials of concerns that are becoming embarrassed. He said: "I can safely say the road has not been in so strong a position as now for at least fifteen years." Shortly afterwards, dividends on the common stock were passed. The company's own reports showed ratios of expenses to earnings of 75% in 1894, 80.2% in 1895, an d 90.2% in 1896. Receivers were appointed in February, 1896, and they at once put the company's records into the hands of competent accountants. Their report was made in March but it was not given out until the following December. The report showed an overstatement of income during the period of seven years and two months which their report covered, as follows: Overstatement of net income $ 2,721,068 Mischarge of worn-out equipment to profit and loss 2,843,596 Improper capitalization of charges under heads of con- struction and so on 2,064,741 Improper capitalization of so-called improvements and betterments 3.57St4S3 ~ Total $11,204,858 Earnings had been increased by crude and arbitrary means. In 1892 the value of Western Union stock in the Baltimore and Ohio treasury had been written up by $468,038, and the stock of the Consolidated Coal Company by $114,300. Advances to 979 980 CORPORATE FINANCE [Bk. II- branch lines had been entered as assets and interest on these advances had been credited to income, although there was no reasonable probability that either one would ever be paid. The report revealed indorsements by the company of notes of sub- sidiary companies to the extent of $5,481,835.1 398. Misleading Statements The juggling of corporate accounts so as to present false or misleading statements to the general body of shareholders and to the public is extremely varied in form, but in spite of its technical intricacies the general idea underlying it is simple enough. In most cases, certain assets are overvalued or certain liabilities are understated for the purpose of swelling the earn- ings. For example, the value of the capital or investment assets, such as buildings, machinery, and other equipment may be in- flated by not writing off sufficient depreciation, with the conse- quence that earnings are exaggerated and surplus is fictitiously enlarged. On the other hand, if the design is to conceal a high rate of earnings, certain assets are undervalued, or certain liabilities are overstated. For instance, if excessive amounts are written off periodically for the depreciation of the capital assets, the reported earnings will be less than the real earnings and a portion of the actual surplus will be concealed. In a corporation which is the parent of a number of subsidiary companies, the methods of juggling accounts are more compli- cated and less easily traced. This is largely because the state- ments of the subsidiary concerns are not separately shown. The earnings of these companies may be falsified by the methods described above, and yet the published statement of the parent company may be perfectly regular so far as it alone is concerned. To guard against disclosures, devious methods are resorted to. These when analyzed consist of a shuffling of assets and lia- 1 Daggett's Railroad Reorganization, pp. 20-23. Ch. 38] EXPLOITATION BY DIRECTORS 981 bilities between the subsidiary companies, so that the record of these transfers is a maze of cross-entries on their books of account and the real conditions can be discovered only by expert accounting investigation. The ultimate objects sought in the deliberate juggling of accounts are also varied. One of the most common purposes is to make as good a showing as possible for the administration that is in power. Either it is hoped that later prosperity will permit the subsequent correction of any inflation of values that may be written on the books, or misrepresentation is resorted to as a desperate measure simply to stave off a revolt among the share- holders. Another common purpose is that of giving the officers and directors a chance to buy or sell shares of their own company on the basis of the misleading statements which they put out. The simple process of purchasing shares below their true value on the strength of a poor, published statement and later reselling them in a boom market on the strength of some grossly inflated state- ment of earnings, has been so often repeated that it has become a twice-told tale, and in the larger corporations is not often attempted. The growing demand for adequate publicity has been a strong factor in suppressing the practice. The growth, also, of a well-educated financial public and the development of financial periodicals which are constantly reviewing and analyz- ing published reports and statements, have been other important factors. But while the old-time process has been refined, there has not been a total disappearance of the underlying purpose, which is to mislead outsiders into selling at a deflated, or into buying at an inflated price. In order to accomplish this, active steps are not always necessary; good news may be withheld or extravagant rumors of anticipated profits may be circulated. Some obscure change in methods of calculating reserves may be enough in the course of time to bring about decided variations from normal in the published statement of earnings and of surplus. 982 CORPORATE FINANCE (Bk. II- 399- Use of Inside Information A Banker's Opinion Is a director morally justified in taking advantage of his official position to make profits for himself? Certainly a director who realizes that his company is doing well and has good pros- pects is not to be blamed for going into the open market and purchasing more of its shares. In so doing he merely shows a proper confidence in the future of his company. On the other hand, when his business judgment tells him that dark days are ahead, is there any reason why he should not sell his shares to others whose opinions differ from his own? The distinction between what is proper and what is improper is perhaps to be found in the principle that the director may buy or sell as he chooses, so long as he is not basing his action on information that ought properly to be made public. The application of that principle is naturally left with each man's conscience. The question as to whether directors ever have the right to use inside information for personal profit was the subject of a highly interesting investigation carried on some years since by a member of the editorial staff of the New York Annalist. The investigator went direct to a number of prominent directors, whose opinions he quotes. The question was first put, according to the investigator, to one of the best-known bankers in the United States, who is a director in many corporations, including financial institutions, industrial companies, and railroads. His answer was in part as follows : If we were all Christian gentlemen with a very fine sense of honor, I suppose no director would buy or sell stocks in his own company on information which comes to him as a director. As a practical matter nearly all directors do. If a director was a trustee it would be a different matter, but so far as I see he is not that. He is an administrator on behalf of himself and of other stockholders, but he does not surrender his individual freedom when he becomes a director. If it were held that a man's holdings of a stock should be frozen up the moment he becomes a director, he being put under obligation neither to add to them nor to reduce them, I fancy verv few could be induced to become directors. Ch. 38] EXPLOITATION BY DIRECTORS 983 There is this question to be considered. A director gives his time and ability to the management of a corporation and gets $20 a week if weekly meetings are held. That is surely not compensa- tion enough. What the director can make in the market on the basis of what he learns as a director is part of the pay which he gets for his work. It might be better if directors were paid a sum commensurate with their services and were then barred from deal- ing in their own stock, but as a practical matter it is not so. 400. Use of Inside Information Wall Street Opinions A more advanced position is taken by a wealthy and in- fluential man described as "one of the self-made men of Wall Street," who said: I am a director in both railroads and industrial companies and I know of my own knowledge that the chance to trade on inside information about railroad properties has become very small. Earnings are reported too frequently for that. It is different with industrials. They do not report monthly, nor in all cases even quarterly, and between one annual report and another there is room for the use of inside information. There is a good deal of exaggeration about the big profits insiders make in the stock market. If they buy or sell they take a market risk and they are often wrong despite their inside information. Personally I am in favor of more frequent reports by industrial companies. The next man interviewed took almost the contrary attitude, although even his remarks indicate a great advance over some of the practices that have been above described : As for the director's right to use advance information to his own advantage, you must grant that self-preservation is the first law of society. A director has put his money into a company, given it a lot of his time, and is entitled to increase or diminish his investment in it on the basis of information which has not yet become public. If he knows of a profitable contract about to be closed, he has more right than anyone else to benefit by a rise in the stock on the announcement, because he has helped to get the contract. Should he see bad times coming he is not morally bound to sit tight and see his shares decline. He has a right to sell his holdings, and he usually does. 984 CORPORATE FINANCE [Bk. II- An executive committee, of which I am a member, frequently meets at 3:30, adjourns for dinner and resumes discussions after- wards, lasting until late in the evening. We each get $20 for attending. Recently we were able, by dovetailing our knowledge and experience, to put a transaction through that netted the com- pany $500,000. The total cost of our time to the company was under $200. 401. Use of Inside Information The Ethical View The argument thus given is controverted by another director a partner in a private bank who says: It is no argument to say that a director is not paid because he only gets his weekly or monthly fees for attending meetings. He is paid in the better insight into affairs which he is given. Being a director in two or three companies makes his time worth more to his own business. Paying a director several thousand dollars a year would make no difference in his speculations. If he speculates when he gets only fees, he will speculate just the same on a salary. The opinions above expressed are in many respects disap- pointing to those who believe that a directorship is primarily a position of trust, the holder of which should feel under the most exacting obligations of honor to work for the best interest of the general body of stockholders. The first directqr above quoted specifically denies that a director is a trustee and calls him an "administrator on behalf of himself and other stockhold- ers." The distinction seems to be largely verbal, for the under- standing that the director represents others and not merely himself remains undenied and undeniable. He surely cannot be said to be fulfilling his duties as a representative dropping the word "trustee" for the moment if he makes it his business to buy or sell stock on the basis of information that is concealed from those who are not members of the board. 402. The New Haven Railroad Exploitation The facts brought to light by an investigation of the Inter- state Commerce Commission into the affairs of the New York, Ch. 38] EXPLOITATION BY DIRECTORS 985 New Haven and Hartford Railroad afford a striking example of the manner in which corporate affairs should not be handled. The Commission's report was published July 15, 1914. It appears from the report that the affairs of the New Haven had been managed for several years with remarkable laxity and extravagance. Although the directors were for the most part men of large wealth and of business standing, they left the actual control of affairs even of broad policies in the hands of Presi- dent Mellen and of certain prominentdirectors. President Mellen himself was frequently uninformed as to the policies and in many cases as to the actual transactions on behalf of the rail- road, which were put through by the small group of inside directors. Most of the members of the board seem to have become obsessed, under President Mellen's influence, with the idea that the New Haven Railroad should achieve complete control, at any price, of all the transportation agencies in New England. With that idea in mind, they approved expenditures for railroads, trolley lines, and steamship companies, which their ordinary business judgment would not have indorsed and which turned out disastrously. The result was the practical wrecking of a prosperous railway with serious, and in many cases disas- trous losses to thousands of its stockholders. 403. "Squeezing" the Minority Stockholders Exploitation is not confined to officers and directors as such. The circle of schemers may be enlarged to include a majority of the shareholders who exploit the minority shareholders, or it may be further enlarged to include all the shareholders who are banded together for the purpose of exploiting the company creditors. An excellent example of what may happen to minority stock- holders may be taken from the history of the National Salt Com- pany. This company was organized in 1899 and the majority of its stock was secured by another concern, the International Salt Company, in 1901. The minority of the National Salt 986 CORPORATE FINANCE [Bk. II- holders, however, refused to exchange their stock and held out for better terms than those offered by the International Company. After the International management came into control of the National Salt Company, its previous liberal earnings showed a sudden decline and the company became heavily involved in debt. Plausible reasons were offered for the decline and the new president remarked in his report that, "the existing debts were created before the present officers came into power." In August, 1902, the need of the National Salt Company for money was so great that it offered at auction sale a large part of the securities of subsidiary salt companies which it had held in its treasury. These securities were bid in for $450,000 by agents acting for the international Salt Company. Shortly afterward a judgment for $228,000 was entered by default against the National Salt Company on notes payable on demand to the International Salt Company. During the first six months of the same year the business had produced a net deficit of $174,000 and the current obligations exceeded the quick assets by nearly $300,000. In September, 1902, receivers for the National Salt Company were appointed. The natural result of the receiver- ship was to bring about the dissolution of the company and the sale of its assets, enabling the International Salt Company to acquire possession of the company's property without settling with the minority stockholders. It would hardly be worth while to enter into greater detail as to methods of exploiting minority shareholders. Perhaps the most common plan is to pay all the profits that are earned into the treasury of some other company owned by the majority shareholders. The payment may be made on any one of a number of pretexts. If the corporation is small, the minority shareholders may find that every member of the majority party becomes an officer of the concern, and that all the profits are paid out relentlessly in the form of exorbitant salaries to these stock- holding officers. Ch. 38] EXPLOITATION BY DIRECTORS 987 404. Exploiting Creditors The Chicago and Alton Episode Among small trading corporations the scheme is not unknown of purchasing a line of goods on credit, disposing of the goods, paying out the cash on some pretext, and permitting the com- pany to go into bankruptcy. Operations of this kind are, in most instances, clear-cut acts of fraud and do not therefore fall within the scope of this chapter. There are, however, some examples on a larger scale of similar actions. The creditor of a modern corporation counts as a por- tion of his margin of security the accumulated surplus of that corporation. As has already been set forth, this surplus be- comes in effect a portion of the permanent capital investment and is usually regarded as not available for payment of divi- dends. Hence, when a bond issue of a corporation which main- tains a surplus is floated, the issue is sold partly on the strength of the showing of surplus on the company's balance sheet. In 1899 a syndicate bought control of the Chicago and Alton Railroad Company, and in 1900 brought about a reorganization of the company. It was found by the syndicate's accountants that during the previous thirty-five years large sums had been charged to operating expenses which had really been invested in betterments and additions, and this sum was found to amount to over $12,000,000. In recapitalizing, the syndicate sold $22,- 000,000 of 3>% bonds, and out of the cash receipts declared a special dividend of over $6,000,000, which was indirectly charged against uncapitalized construction expenditure of $12,444,170. In other words, the syndicate first sold bonds to raise cash and then distributed a substantial portion of this cash to themselves under the guise of dividends charged against surplus. The process of paying dividends out of the cash secured through the sale of bonds is scarcely defensible under any cir- cumstances. In this particular case the transaction can hardly be regarded in any other light than as exploitation of creditors who bought the bonds in good faith on the assumption that their money would be used for future betterments, g88 CORPORATE FINANCE [Bk. II- 405. Interborough Rapid Transit Exploitation Another instance of exploitation of creditors is furnished by the Interborough Rapid Transit Company, of New York City. In the investigation into the company's affairs conducted by the State Transit Commission during November and December, 1921, it was disclosed that out of the total net income of $67,- 867,878 earned during the eighteen years of the company's life, $65,625,000 was disbursed in dividends, with the result that on June 30, 1921, the profit and loss surplus as shown on the com- pany's books amounted to only $2,242,878. But even this, according to the testimony of the Commission's accountants, was greatly exaggerated, as proper allowance had not been made for certain bad debts and the amortization of the value of a subway lease of limited duration. It was virtually admitted by the company's auditor that if these and other proper deduc- tions had been made, the gross earnings, instead of a profit and loss surplus, would have showed a deficit of $12,000,000. The Commissioner's investigations seemed to show that dividends had been paid for some time after current earnings fell far short of meeting them, at least one disbursement having been made out of the proceeds of loans from banks and the parent company. In its more prosperous days the company was also lavish with its funds in other directions, large bonuses having been voted and paid to the president of the company, its general counsel, and the chief auditor. 406. Precautions Against Exploitation Selection of Directors The obvious remedy against exploitation, it may therefore be suggested, would be for those shareholders who desire honest management to elect only directors of unimpeachable honor or to refuse to buy the securities of corporations which do not have such directors. As a matter of fact, this is the fundamental remedy and it is gradually being applied. But human nature is too slowly changed to make this remedy effective except over a period of generations. Ch. 38] EXPLOITATION BY DIRECTORS 989 As matters stand today, it is quite impossible for the average shareholder of a large corporation to secure much information as to the personal characteristics and standards of the directors of his corporation. Even in small concerns, where the share- holders may be personally acquainted with each other and with the directors, it is often extremely difficult to gauge with any accuracy the true characters of the men who are in control. Of course, there is always room for the exercise of judgment. No one of good sense would deliberately place his capital under the control of men who are known to be of bad character. The corporate shareholder, however, is always confronted with the possibility of having overestimated the characters of the men in charge, or again of seeing the control of the enterprise trans- ferred into the hands of unscrupulous tricksters. For these reasons, the suggestion that each individual can protect himself from exploitation simply by carefully choosing the directors to whom he entrusts his capital, is true only within quite definite limits. 407. Precautions Against Exploitation Special Provisions in Charter A second suggestion has recently been made by T. Mulvey, formerly Assistant Secretary of State, Ottawa, Canada. Writing in the American Economic Review, Mr. Mulvey first discusses the four methods named below of tiring out the minority stock- holders and leading them to sell their stock at an abnormally low price : 1 . Piling up huge undistributed surplus. 2. Making a contract with a subsidiary company which permits the subsidiary company to take most of the profits. 3. Paying out profits in the form of exorbitant salaries. 4. Selling out the profitable features of the enterprise to a new company, which is promoted by a majority of the stockholders. 990 CORPORATE FINANCE [Bk. II- Mr. Mulvey then points out that all these abuses may be controlled by suitable provisions in the charter or by-laws of the company, and says: Salaries may be limited, the dealings with subsidiary com- panies for the purpose of withholding profits may be regulated, methods of accounting may be devised whereby dividends may not be withheld. A sale of the undertaking may be prohibited, except with unanimous consent. The shareholder has a contract with the company which is made up of the statutes, charter, and articles or by-laws. These may be framed so that exactions or overbearing methods of the majority may be eliminated. It is quite true, as Mr. Mulvey suggests, that the charter and by-laws should be more carefully framed than is usually the case. They should provide, for instance, for cumulative voting, which assures even a small minority of some representation on the board of directors. In a few companies, the business of which is specially well stabilized and standardized, salaries, contracts, accumulation of surplus, and sale of assets may all be regulated. These companies, however, are relatively few in number. The great majority of enterprises must be highly flexible in order to be successful. The difficulty of placing limitations of the kind Mr. Mulvey suggests, without at the same time hampering the free action so essential to business success, seems in most cases insuperable. It may be noted that Mr. Mulvey does not discuss the follow- ing two methods of exploitation which are of great importance whenever officers or directors desire to take an unfair advantage of their official positions: first, misrepresentation, i.e., the sus- tained policy of creating false impressions; and second, misuse of inside information. It would be hardly possible to prevent either of these abuses by regulation. And so long as they are available, officers and directors have it in their power to mislead their associates and often to procure their approval of actions which more complete information would show were detrimental to their interests. Ch. 38] EXPLOITATION BY DIRECTORS 991 408 . Precautions Against Exploitation Publicity The most powerful weapon available for the victims, or possible victims, of exploitation is publicity. A shareholder in a corporation, large or small, who feels that he and his associates are being defrauded, who has a clear case and who is willing, with his eyes open, to enter into a long and gruelling fight, is likely to find simple publicity a highly effective and, if properly used, a highly legitimate method of attack. In a large corpora- tion the campaign of publicity may be directed not only toward stockholders, but toward the public at large. In a smaller cor- poration it will naturally be confined to people who are directly affected. It goes without saying that whatever statements are publicly made must be clearly based on unmistakable evidence presented without personal bias. A single statement that is incorrect may be fatal to the whole case and may involve the one responsible in serious personal difficulties. Through the use of effective publicity of the best type in 1906, Charles E. Hughes, now Secretary of State, carried through an investigation of the prominent life insurance companies, which at first was apparently of small importance, but which ultimately brought about, through the pressure of overwhelming public sentiment, a complete revolution in the financial management of the life insurance companies and a permanent uplift in stand- ards of business morality. Later, N. L. Amster, of Boston, carried on a campaign in behalf of the Rock Island stockholders which resulted in an agreement to select by general consent a new board of directors in whom all the shareholders could place confidence. In 1914, the Interstate Commerce Commission used no weapon except publicity in carrying through the investigation of the New Haven Railroad, which revealed the facts that have been previously stated in this chapter and which led through pressure of public opinion to the retirement of the old management and the election of an entirely new group of directors and officers, CHAPTER XXXIX INSOLVENCY AND RECEIVERSHIP 1 409. Two Types of Insolvency The number of business concerns which become insolvent each year averages below i% of the total number. Following is the record for the last ten years: 2 No. of No. of Business Percentage Failures Concerns of Failures IQI2 15,452 ,564,279 -98% 1913 16,037 ,616,517 .90 1914 18,280 ,655,496 1. 10 1915 22,156 ,674,788 1.32 1916 16,993 ,707,639 .99 1917 13,855 ,733,225 .80 1918 9,982 ,708,061 .58 1919 6,451 ,710,909 .38 1920 8,881 ,821,409 .49 1921 19,652 1,927,304 1.02 However, this record does not present a complete picture, for it does not include numberless instances of financial em- barrassment which are settled privately and of which no avail- able record is made. Nor does it include the still larger number of cases where a business concern gradually sinks its capital until finally the enterprise is sold or is transferred on some other contractual arrangement, thus bringing the enterprise into the hands of new men who supply fresh capital which is either sunk and lost or makes the business a success. Sometimes the process of passing a business concern from hand to hand, each new owner losing money until he reaches the point where he is glad to hand it over to someone else, is carried 1 See also Book III, Part VI, "Reorganization, Receivership and Dissolution." 1 Dun's Review, January, 1922. 992 Ch. 39] INSOLVENCY AND RECEIVERSHIP 993 on over a remarkably long period. One instance is that of a small magazine which existed for over twenty-four years. Dur- ing this period its management and control were changed no less than fifteen times, and for the entire twenty-four years it had an unbroken record of losing money, including considerable sums which were sunk from time to time in supplementary pub- lishing schemes, in furniture and equipment of various kinds, etc. During its whole history this magazine was never insolvent and never was known to be in financial difficulties, but never was it successful. Finally it reached the appointed goal of most small magazines and was absorbed by one of its stronger competitors. Doubtless thousands of small retail stores and of many other business lines in which full and accurate accounts are not kept, lose money continuously over a period of years. No one outside the enterprise knows with any definiteness at least that as a money maker, it is a hopeless failure. Often the proprietor himself is not aware of this fact. There are many similar failures on a larger scale. It is stated, for in- stance, that in eighteen years, from 1894 to 1912, the com- bination of cordage manufacturers under its various titles was continuously a business failure. 410. Economic Insolvency The condition of a business in which income will not suffice to cover outgo until its liabilities exceed its assets, may be termed "economic insolvency." If the individual, partnership, or corporation that owns a business in this condition becomes unable or unwilling to put any further capital into it, and is also unable to make an adjustment with creditors and reduce the fixed charges, or to find a purchaser for the business, then the enterprise may come into the courts and be adjudged bankrupt. Economic insolvency is sometimes defined as the condition of a business enterprise that exists when the total value of assets is less than the total amount of liabilities. The net worth, capital stock, and surplus have been dissipated, and an actual 994 CORPORATE FINANCE [Bk. II- deficit exists in their place. In any money -losing corporation economic insolvency will sooner or later come, although it is often concealed for a time by improper accounting. In the end, unless the company succeeds in extricating itself from its in- solvent position before this became known to outsiders, it comes to grief and its affairs are wound up. In the period of severe price decline during 1920-1921, not a few businesses found themselves suddenly threatened with economic insolvency, and, as indicated by the somewhat violent increase of insolvency in 1921 shown by the table on a preceding page, many were forced into bankruptcy. In the business boom preceding the price drop they had accumulated large stocks of merchandise and the crisis came with these heavy inventories on their hands. The cost of the goods far surpassed their current value, and the resulting losses obliterated the excess in the total asset values over and above the liabilities where companies were operating on a too narrow margin of safety. Dividend payments had to be discontinued and a policy of rigid retrenchment of expenses had to be adopted in order to repair the loss. 3 .p':. 411. Technical or Financial Insolvency A second type of insolvency is that which exists when an enterprise that possesses a greater total of assets than of liabilities is unable to meet its obligations. This type is some- times called "technical" insolvency or "financial" insolvency. It may easily happen that an enterprise which is a great busi- ness success may in this sense become insolvent. There have been previous references to the two insolvencies and reorgani- zations of the Westinghouse Electric and Manufacturing Com- pany, which has always been a money-making enterprise. This second type of insolvency is probably more common than the first. It is due, not to intrinsic weakness in the busi- ness, but to errors in its financial management. ' See inventory statistics in 381. Ch. 39] INSOLVENCY AND RECEIVERSHIP 995 Factors making for this type of insolvency result in no actual loss of asset values, but merely in poorly balanced dis- tribution of values as between fixed and liquid assets. Factors making for economic insolvency, however, cause actual loss of asset values, and therefore reduce the company's net worth. 412. Causes of Insolvency J The causes of failures, as summarized by the commercial agencies, may be grouped in two main classes: (i) causes for which the management of the failing concern may be held responsible, and (2) outside factors over which the business can exercise little or no control. In the first group we find such causes as lack of capital, incompetence on the part of the management, the granting of unwise credits, etc. About 80% of all failures in this country are due to this group of causes. The second class includes such factors as losses by storms, floods, and similar disasters, unexpected failures of other con- cerns, severe competition, etc. This group of causes accounts for approximately 20% of the* failures in the United States. 413. Lack of Working Capital According to the mercantile agencies, the cause of a little more than one-third of the legal insolvencies in the United States is "lack of capital." This is rather a vague phrase which in the great majority of instances should probably be interpreted to mean "lack of working capital." By far the greater number of business enterprises can be made successful on a small scale even though their working capital may be very limited. It is when these enterprises begin to expand and go beyond the prudent limits imposed by their small amount of available working capital, that they tend more and more to convert working assets into fixed assets and finally reach a point, if care is not exercised, where they cannot raise the ready cash with which to meet maturing obligations. If we were to 996 CORPORATE FINANCE [Bk. II- call the basic trouble in such cases "mismanagement of capital," we should not be far from wrong. There are exceptional cases, of course, in which a minimum amount of capital is required in order to equip a plant or carry a sufficient stock of merchandise. It is stated, for example, that a modern sugar refinery which expects to enter into active competition with those already in operation, cannot be built and equipped for less than from $3,000,000 to $5,000,000. Consequently, a sugar refining enterprise started with a capital of $1,000,000 would have to build a small and inefficient plant, or else issue interest-bearing obligations to such an extent as to endangei its financial safety. The minimum limits of capital in each industry are so well known to those acquainted with the industry that there are probably comparatively few instances in which a business is started by those familiar with its requirements without sufficient capital if properly handled to carry it through to at least a moderate success. 414. Over-Extension Financial embarrassment due to inadequate working capital is frequently ascribable to the failure of the company to maintain a proper balance between fixed and liquid assets as determined by the cash requirements for meeting obligations currently falling due. In the first place, the company may become over- extended with reference to its capital assets. Too much of its cash, at least for the time being, has been expended, perhaps, in a new building and equipment program. The improvements and extensions may eventually prove to be very profitable investments, but long before this comes to pass they have taken the available funds from the company's treasury and the cash on hand is insufficient to pay the obligations falling due in the regular course of business. The only remedy in that event is for the company to get outside money, that is, to raise cash by either selling new stock or issuing new bonds. But if the Ch. 39l INSOLVENCY AND RECEIVERSHIP 997 sale of its securities is impossible because of its low credit or because of the unsatisfactory conditions in the general invest- ment market, nothing remains but, through receivership or otherwise, to come to such adjustment as may be possible with its creditors. A similar situation, though not quite as serious in its effects, may result from the tying up of too much of the company's available funds in merchandise inventories. The company may accumulate in anticipation of increased sales a much larger stock than it usually carries. But if it has misjudged the market for its goods and the sales prove disappointing, and cash does not flow into the treasury in sufficient volume to meet the current needs for disbursement, now increased by payments for the additional inventory, the company will find itself unable to pay its obligations. But even though the sales should meet expectations, if the company has been too liberal in its selling policy, and has not scrutinized sufficiently the financial standing of its customers, its collections may prove too slow to offset its outgo. Then unless the company can borrow of banks, or on its accounts receivable, it may be compelled to ask its creditors for an extension of time. Of course, actual losses through uncollectible accounts, if of sufficient volume, will lead to economic insolvency. 415. Anxiety to Pay Dividends A frequent cause of technical insolvency among industrial combinations has been excessive anxiety on the part of directors to pay dividends. Many industrial combinations are started on the basis of excessive anticipation of profit, which has been aroused by glowing prospectuses, and the organizers feel called upon to "make good." Dewing states that in most of the cases of failure cited by him, financial difficulties were not caused by overcapitalization, as is usually alleged, but were directly due to the deflection of working capital to the paying of interest and dividends. Beneath these, as the fundamental 998 CORPORATE FINANCE [Bk. II- cause, was the lack of judgment of promoters in raising money by bond issues on untried enterprises and in some cases undue haste to pay dividends before accumulating proper surplus and reserves. 416. Unfavorable Market Conditions Another immediate cause of technical insolvency, which is quite frequent among railroad corporations, is inability to meet maturing obligations by reason of market conditions which prevent the sale of refunding securities. A company may be reasonably sound and well able to carry its load of indebtedness and yet may find itself in no position when market conditions are unfavorable, to refund maturing bonds. This situation will very seldom arise with a corporation that enjoys really high credit, but it may easily arise with one that enjoys only fair to medium credit. The fact that an obligation falls due at an inconvenient time may be regarded as in one sense an accidental misfortune, though in another sense the corporation, if well handled, would hardly find itself in difficulties by reason of an unreceptive market. ' "^ 417. Methods of Procedure in Case of Insolvency When a business enterprise is unable to meet its debts and is known to be insolvent, four courses of action are open: 1. Creditors may agree voluntarily to a "readjustment" or settlement of their claims. This can be done only when all the creditors are reasonable and have considerable faith in the management of the enterprise. In that case they may prefer, for their own sakes, that the situation should be kept out of the courts and out of public records and that the buiness should go on with as little disturbance as possible. 2. The corporation may voluntarily dissolve, divide its assets among its creditors, and go out of business, all without the intervention of the courts. Ch. 39] INSOLVENCY AND RECEIVERSHIP 999 3. The individual, the partnership, or the corporation owning the enterprise may be adjudged a bankrupt, and a re- ceiver in bankruptcy be appointed to dispose of the assets and distribute the proceeds. 4. The corporation may secure the appointment of a receiver in equity whose function is to carry on the business and at the same time assist, so far as he can, in working out a generally satisfactory plan of reorganization. kg F ~, . 418. Readjustment of Claims The first of these remedies is unusual, except among the creditors of small corporations. It requires a degree of har- monious action that is almost impossible to bring about among a great number of people. The attempt, however, was made in July, 1915, in the case of the Missouri Pacific-Iron Mountain system under the auspices of one of the great banking houses of America, Kuhn, Loeb and Company, who acted as readjust- ment managers. The details of the plan of readjustment need not, for this purpose, be considered. The point that interests us here is the fact that in spite of the obvious merits of the plan, its remarkably strong backing and the general indorsement of the financial press and of financial authorities, the final results were disappointing. It proved to be impossible to secure the voluntary assent of all, or practically all the security holders, and it was found necessary to go through the cumbersome and expensive process of reorganization. A similar attempt was made in 1913 in the case of the Hudson and Manhattan Company which operates the underground railway system through the Hudson River tunnel. In this instance the number of holders of obligations was much smaller and the plan of readjustment was successfully carried through. This plan is a very common procedure with smaller companies and, wherever practicable, is by far the most economical and most satisfactory method of meeting a condition of insolvency. Its success, however, is always dependent upon the presence of 1000 CORPORATE FINANCE [Bk. II- a fair degree of mutual confidence and good faith among the various parties concerned.. A typical embarrassment which did not involve any legal action is illustrated by the recent case of a $2,000,000 printing and lithographing firm in New York City. This company had outstanding notes for $400,000. At first it was thought to be in bad shape and the banks holding the notes were undecided whether any further accommodation should be extended. Representatives of the banks talked over the situation and a meeting of the creditors of the company was held at which a committee of five was appointed to decide on the proper steps to save the firm and protect its creditors. This committee agreed to put the head of a stationery and printing house in whom all the creditors had confidence in temporary charge. He reported that the company had a cash balance of $51,780, unfilled contracts on hand worth about $1,000,000, and bills receivable of $150,000. On the strength of this report the creditors agreed to wait two years for a settlement of all claims. Later developments proved the wisdom of their action, as the company regained a firm footing and did a profitable business. The following quotation from the Wall Street Journal* describes a similar effort now under way : _ w Oi A plan dealing with the indebtedness of the Columbia Grapho- CO phone Manufacturing Co., which provides for freezing the entire -^ ^^ 5 debt of the company for the period from April i, 1922, to August I O 3 o i, 1925, after deducting an amount not in excess of aggregate bank S p g 33 deposits on September 15, 1921, has been approved by the com- m ^ mittee formed to protect the interests of holders of the five-year j " p "5 8% notes, the bankers' committee and committee representing "7* > -| merchandise and supply creditors. Total debt involved will be { y> r around $20,000,000. This means that both interest and principal ^ O ^ ^ (if due in that time) will be deferred for three years, at the end of which time, interest adjustments will no doubt be considered if > company works out of present difficulties. * April 8. 1922. Ch. 39] INSOLVENCY AND RECEIVERSHIP 1001 The plan provides for adjustments of interest on all debts to April i, 1922. Provision is also made for appointment of a new committee to represent the total debt, which will rank equally. This committee, known as the readjustment committee, is com- posed of M. M. Buckner, Benjamin Joy, J. C. Neff, William C. Dickerman, and G. Herman Kinnicutt. Funding the debt in this way will in opinion of the committee provide opportunity for the company to work out of present finan- cial difficulties. It is not considered that any public financing will be necessary. With approval of the committee, company will be given power to borrow should funds be necessary for working capital. 419. Dissolution of Insolvent Corporations The dissolution of an insolvent corporation and the dis- tribution of the assets is an uncommon proceeding. It requires the consent both of creditors who must trust to the good faith of the officers of the corporat&n in carrying through the disso- lution and distribution ^t^e ^pfxfc^eds, and also of the share- holders who must be conviflcj&^H^tfW* other procedure is pos- sible. It is the feeling amm^ccteaitare and shareholders alike, '>V' 'V VI ^/ that those who have managedCV ^|^rajpn/which has become insolvent, should not be left fre^bQ^^m$k own arrange- ments for winding up the company, ^jjr^^id b checked and supervised by some responsible officer whd^mls>see that all the facts are disclosed. It is because of this feeling^that the remedies of voluntary readjustment and of dissolution are so seldom used, and that the remedies of bankruptcy and receivership are almost always necessary. 420. Voluntary Dissolution Dissolutions are not always due to insolvency, but may come as the result of pressure of other kinds or as the result of a conviction on the part of a majority of the shareholders that the corporation, while not actually insolvent or losing money, is nevertheless making an unprofitable use of the capital invested and is actually going backward. Under these condi- 1002 CORPORATE FINANCE [Bk. II- tions, it may often be the part of wisdom to bring about a dissolution while the company still possesses a valuable surplus. A number of special cases of partial dissolution which might also be described as a partial distribution of assets have arisen in the United States recently, due to decrees of the courts requiring "combinations in restraint of trade" to resolve them- selves into their constituent elements. The practical application of these decrees has in many cases involved peculiar difficulties. A typical instance of this kind is the ordered dissolution of the combination represented by the Reading Company. This company is a purely proprietary or holding company, whose assets consist exclusively of securities in other companies. These assets include the entire capital stock of the Philadelphia and Reading Railway Company, the Philadelphia and Reading Coal and Iron Company, the Philadelphia and Reading Terminal Company, the Reading Iron Company, and $14,504,000 of the outstanding $27,436,800 capital stock of the Central Railroad Company of New Jersey. The government brought suit against this combination on the ground that it was in restraint of trade and therefore in violation of the Anti-Trust Law. In 1920 the United States Supreme Court handed down a decision compelling the Reading Company to dispose of as much of its security holdings in the other companies as would be necessary to restore their mutual independence. Steps were immediately taken to obey the court's mandate, but in the process of segregation very perplexing difficulties have been encountered, and so serious are these, that although two years have passed since, the Supreme Court decree was entered, no definite plan of dissolution has yet been put in operation. Another instance of voluntary dissolution was the winding up of the business of the United States Express Company, a concern that was solvent though gradually losing ground. The company decided that in the face of the competition for express business, and particularly on account of the competition of the newly established parcel post, it would be best to liquidate Ch. 39] INSOLVENCY AND RECEIVERSHIP 1003 its assets and withdraw from the field. Fortunately, there was little duplication of contracts or facilities among the express companies and most of the company's property could be dis- posed of to the remaining express companies at reasonable appraised valuations. In this way the liquidation was carried through without serious loss or difficulty. Ordinarily there is no special financial skill required in handling a voluntary dissolution, which consists simply in gradually closing down the business, disposing of the assets,, and distributing the proceeds to creditors and shareholders. Yet even this comparatively simple procedure frequently involves a vast amount of detail work. ' 421. Origin and Nature of Bankruptcy In the early English law an individual was declared bankrupt for the purpose of enabling his creditors to seize upon and distribute his assets. In case the assets did not prove sufficient to meet his debts, he was held personally subject to the remaining claims of his creditors, and in default of payment was thrown into jail. Within the last 150 years, however, the popular and legal conceptions of bankruptcy have been greatly modified. In the United States bankruptcy proceedings are governed by the National Bankruptcy Act of 1898 as amended in sub- sequent years, and the courts having jurisdiction are those of the federal government. The purpose of bankruptcy proceedings is no longer merely to protect creditors, but also to free the bankrupt from a load of debt that had become insupportable and to set him on his feet again as a useful member of the business community. There are abuses, to be sure, of this modern practice of bankruptcy. There are cases in which dishonest advantage is taken of the bankpruptcy law, and creditors are defrauded, wholly or partly, of their rightful claims. Some creditors who have suffered from these abuses have gone to the length of advocating a repeal of the law. But most business men realize 1004 CORPORATE FINANCE [Bk. II- that as against the chaotic conditions which prevailed before the passage of the National Bankruptcy Act, the law has proved a blessing to the creditors as well as to the bankrupt. In many cases individuals who have been able to rebuild their fortunes after having gone through bankruptcy, have made it a point of honor to repay in full all the debts from which they had legally been freed. . 422. Two Kinds of Bankruptcy Bankruptcy is of two general kinds, voluntary and in- voluntary. The benefits of bankruptcy are open, not only to natural persons, with a few exceptions, but also to business corporations except those engaged in railroad operation, insur- ance, or banking. These three lines of business are of such general importance that it was thought to be against public interest to permit their operations to be brought suddenly to a close and their assets scattered. The process of winding up banking and insurance companies is provided for under the National and State Banking and Insurance Acts. The definition of "insolvency" as given in the National Bankruptcy Act is, from a legal standpoint, peculiar, although it conforms to the definition of "economic insolvency" that has been given above. A person is insolvent, within the meaning of the bankruptcy law, "when the aggregate of his property, exclusive of any property that he has conveyed, transferred, concealed or removed, or permitted to be removed with intent to hinder, delay or defraud his creditors, is not, at a fair valuation, sufficient in amount to pay his debts." An individual or a corporation being in a condition of insolvency, must then commit an "act of bankruptcy" if the person or the corporation is to be thrown into involuntary bankruptcy. The most common act of bankruptcy is the making of a general assignment for the benefit of creditors. As a general rule, a voluntary assignment for the benefit of creditors is less expensive than bankruptcy proceedings. It requires honor, Ch. 39] INSOLVENCY AND RECEIVERSHIP 1005 mutual confidence, and good faith, while on the other hand bankruptcy procedure is especially valuable in case there is any suspicion of misrepresentation or dishonesty. Bankruptcy is a harsh and, for most corporations, a fatal remedy for in- solvency. It is, in fact, hardly worth while to attempt to rehabilitate a corporation that has gone through bankruptcy. It is usually far easier and better to form a new corporation which will purchase the assets and proceed to carry on the business. 423. Origin and Nature of Receivership Bankruptcy proceedings in the case of an insolvent corpora- tion are usually wasteful and unwise. A better method of meeting this situation is to address a petition to a court of equity for the appointment of a receiver to carry on the business under the supervision of the court, until some plan of reorganiza- tion is worked out. The petition is referred to in some juris- dictions as a "bill in chancery." It may be presented by any one of four parties: (i) by the corporation itself; (2) by the stockholders of the corporation; (3) by the secured creditors; (4) by the unsecured creditors. Applications from the corporation itself or from its own stockholders are rare, and are still more rarely granted. Thus in the early part of 1922, stockholders of the embarrassed Columbia Graphophone Company petitioned for the appoint- ment of a receiver, but later withdrew their petition. Appli- cations from creditors who are friendly toward the corporation are frequently presented, however, and in such cases the court is often requested to appoint one of the officers, or someone else close to the management, as receiver. "Friendly receiverships," as these arrangements are known, are not always warmly favored by the bondholders and other creditors who are usually somewhat suspicious of the management that is responsible for involving the company in financial difficulties. In these friendly proceedings the court sometimes appoints loo6 CORPORATE FINANCE [Bk. II- two receivers, who are to act together one an official of the company familiar with the technical operation of the company, and another with no previous connections with the company, a distinguished lawyer, former statesman, etc., who is the court's chief reliance. Thus in the receivership of the Chicago, Rock Island and Pacific Railway Company in 1915, the federal court appointed H. U. Mudge, former president of the railroad, as one receiver, and J. M. Dickinson, who had been in President Taft's cabinet, as the other receiver. In all disagreements between the two receivers, Mr. Dickinson was given the deciding vote. 424. Conflicting Receiverships An application for a receivership may be addressed to any court, either federal or state, which has jurisdiction over any part of the business of the corporation. As a result it has often happened that two or more courts have each appointed a receiver and conflict of authority has resulted. The tendency, however, has been strong toward putting all receivership proceedings that affect interstate corporations into the hands of the federal courts ; and these courts almost invariably, as a matter of courtesy to each other, act in harmony. The judge who first appoints a receiver, is usually accorded precedence, and other judges appoint the same receiver for the property over which they have jurisdiction. Sometimes the incipient conflict is solved by the appointment of an ancillary receiver, who is expected to co- operate strictly in harmony with the receiver first appointed. 425. Receivers' Duties The purpose for which a receiver in equity is appointed, is usually quite different from the purpose of a receiver or trustee in bankruptcy. The latter aims first to take possession of all the property of the insolvent individual or concern; next to dispose of the prdperty as quickly as is practicable; and third, to distribute the cash that has been realized. A receiver in Ch. 301 INSOLVENCY AND RECEIVERSHIP 1007 equity, on the other hand, has for his function to keep the business running as smoothly and. with as little loss as possible. He may make some changes in methods of administration and may properly retrench whenever he can do so without impairing the efficiency of the property, but in general he carries on the business in about the same manner in which any business is carried on. He aims not to turn the assets into cash, but to keep them working as profitably as possible. Not infrequently .the property of a corporation could not be sold for an amount sufficient even to reimburse the secured creditors; yet as a going concern it may be able to earn normal profits. This is the case, in fact, with almost all companies that have become technically insolvent. They are not, in the first place, properly subject to the Bankruptcy Act, since their assets certainly exceed their liabilities, and to attempt to wind them up would be poor policy for everyone concerned. The best and most common procedure with all such insolvent corporations, as well as with banks, insurance companies, and railroads, is to arrange usually through friendly proceedings for the ap- pointment of a receiver to conduct the business while negotia- tions for its reorganization are in process. 426. Receivers' Powers The receiver carries on his work under the direct authority and supervision of the judge who has appointed him. The closeness of this supervision depends largely on the personalities of the judge and of the receiver, the general practice of the court, and numerous other factors. In general, the receiver makes it a point to secure special authority for acts that cannot be regarded as a part of the routine of conducting the business. Under authority of the court, a receiver may issue obligations known as "receiver's certificates" which constitute a claim on the company's income and assets ranking ahead of all other claims. He may secure new equipment, bring new blood into the management, find new methods of marketing the company's loo8 CORPORATE FINANCE [Bk. II- products, and inaugurate new systems of operation. He is, in fact, the general manager of the company for the time being, with very little restriction upon his actions. Sometimes a receiver will remain in control for two or three years or more before a satisfactory plan of reorganization is worked out. It has been remarked above that the receiver is frequently one of the previous operating officials; on the other hand, it sometimes happens that the receiver makes so satisfactory a record that he is requested, after the reorganization has been completed, to become an operating official and continue to work out the policies which, as receiver, he has inaugurated. F. W. Whitridge, for example, after successfully operating the Third Avenue Railroad Company in New York City as receiver, became and until his death continued to be president of the reorganized company. 427. Customary Results of Receivership It is frequently the case that a corporation which becomes insolvent has for several years been running downhill, either because of incompetence or exploitation on the part of the management, or because the impaired credit of the company has not permitted it to raise new capital with which to bring its plant and equipment up to modern requirements. The appointment of a receiver, instead of being another step down- ward, may prove to be the company's salvation. That depends in part, of course, on the character and ability of the receiver. If he is a man of ideas and of executive talent, he may quickly rejuvenate the organization. As has just been noted, the receiver has the power to issue certificates and thus secure funds which had previously been lacking. Sometimes a comparatively small amount of new capital will be enough to put a decaying corporation back into a moderately sound condition. The receiver has a free hand. If it is possible to do anything for the corporation and if he is the man to do it, the results of his activities may be a gratifying gain Ch. 39] INSOLVENCY AND RECEIVERSHIP 1009 in efficiency and earning power. In any event, the receiver should be able to hold the organization and the property intact and to turn back, after his service is completed, a business which at least is none the worse for the receivership. Ordinarily the receiver takes some part also in an informal way in the negotiations for financial reorganization of the business, and advises with the court as to the plan of reorgani- zation that ought to be approved. It is an object of his efforts to bring about the reorganization and thus terminate the re- ceivership at the earliest possible moment. Very infrequently it happens that these customary results- maintenance of a going business and financial reorganization are not attainable. And in that case the receivership may finally end in a forced winding up of the business. Thus in the early part of 1922, the receiver for Robert H. Ingersoll and Brother was unable to continue the business, and as no feasible plan for its rehabilitation or reorganization could be worked out, the business was sold. Although unusual, it is possible even for a railroad, like other business enterprises, actually and completely to go out of busi- ness. In October, 1914, the judge having jurisdiction signed an order directing the receivers of the Buffalo and Susquehanna Railroad to discontinue permanently the operation of trains, to take up the company's rails, and to dispose of its assets. It is stated that the total population served by this railway, which was 86 miles in length, was only about 17,000; consequently the railroad was wholly unable to pay its own operating ex- penses. At the time when the receiver wound up the business, all that was left to the owners of $6,000,000 par value out- standing bonds (to say nothing of outstanding preferred and common shares) was the scrap value of the rails and rolling stock, the right of way, and 23 acres of land fronting on Lake Erie. CHAPTER XL REORGANIZATION 1 428. Financial Reorganization Defined In England the term "reconstruction" is used to describe the process that we ordinarily call "reorganization." The English word is better chosen as it embodies the idea which underlies the whole process that of tearing down the old financial structure and using the materials in a new and stronger structure. Financial reorganization, in its proper sense, is not merely a series of compromises and forced sacrifices imposed upon security holders. It is a rearrangement of the company's liabilities so as to make them conform more closely to the assets and earnings. If it is worked out on ideal lines the reorganiza- tion may be described as a new financial plan which replaces the old plan that has proved faulty. The readjustment of the company's finances should enable it to proceed thereafter under more favorable conditions and to achieve better results. The final plan of reorganization must be approved by a sufficient number of security holders and must also have the approval of the court. The relative influence of the security holders, on one side, and of the judge and receiver, on the other side, varies greatly in determining the plan of reorganization; and it is probable that in complicated reorganizations, especially those of railroads, it is more often necessary for the courts to intervene and take an active part in formulating a plan than it is in the simpler cases of reorganization, particularly of industrial corporations. 1 For accounting treatment of reorganization, see Book III, Chs. XXIX-XXXI. IOIO Ch. 40] REORGANIZATION ion 429. Conflicts of Interests in Reorganization The various interests which are concerned in a financial reorganization may ordinarily be classified in three groups, as follows : 1. The creditors, including bondholders. 2. The shareholders, both preferred and common. 3. The banking houses which propose to underwrite the reorganization plan. In a complicated reorganization, each one of these three groups is subdivided. There may be a number of bond issues which have claims that in part conflict with each other. The interests of the preferred and of the common shareholders are by no means identical. There may be two or more banking houses that are working with an eye to handling the underwriting. It may often happen, therefore, that there is a complex struggle among the various groups of interests. On some questions there may be agreements and alliances between two or more groups, and on other questions the cleavage may be entirely different. Naturally the chief influence is exerted by the bondholders, especially by the holders of those issues which are well protected by prior liens. Next come the holders of the junior lien issues. The bank- ing houses are likely to be in close touch with all the different groups of bondholders and advise with them. Inasmuch as the active assistance of some good banking house is essential in order to make any plan a success, the representative of such a house is likely to be consulted and to have a voice in determining all important questions. Moreover, he is in the advantageous position of an outsider who may be trusted to view the situation impartially. As for the shareholders in a drastic reorganization, they have little to say. Indeed, it sometimes happens that their claims to recognition are ruthlessly brushed aside and they are practically wiped out of existence. However, as we shall see, 1012 CORPORATE FINANCE [Bk. 11^ they are frequently needed to supply the fresh cash required for the reorganized company, and for that reason are permitted to have some voice in working out the reorganization plan. The officers of a failed corporation sometimes undertake to direct the reorganization, but their efforts are seldom welcomed. The receiver, as we have seen, sometimes takes a fairly active though informal part in working out the reorganization plan. In view of all these complications and of the practical difficulties in working out an effective reorganization, it often requires months or even years to complete the plan. In the larger reorganizations there is likely to be considerable dis- cussion, not only among- the security holders but also in the financial press. Attempts to curb and stifle this discussion are sometimes made and usually are unfortunate. The security holders of a company in process of reorganization are by no means entirely helpless. The assent of a large proportion of the holders of each bond issue is usually required before any plan can be made effective; consequently the reasonable requests of security holders for explanations and for information in regard to the condition of the company cannot wisely be denied. . It is, of course, always possible for those in charge of a corporation or of a reorganization, arbitrarily to refuse to proceed with a discussion, but the effect is not likely to be helpful to their cause. 430. Formation of Committees In present-day practice one of the immediate results of the announcement of insolvency of an important corporation is the formation of a number of security holders' committees, each one representing a certain security issue. Sometimes one committee may represent two or more issues, the interests of which are not conflicting. The process of formation of these committees is nearly always something of a mystery. They seem to spring up sometimes overnight without special authority. As a matter of fact they are usually self-appointed and each Ch. 40] REORGANIZATION 1013 committee is, in reality, simply a group of individuals who have determined among themselves that it is wise and proper for them to solicit authority from their fellow security holders to act in their behalf. In order to secure this authority, it is essential that the members of the committee should either be personally well known to the security holders or should be connected with important firms or banking houses. In large reorganizations, membership on these committees is regarded as something of a prize. The members are frequently allowed generous fees for their services and do not, as a matter of fact, have many onerous duties. The detailed work is usually handled by the secretary of the committee or by counsel. However, it would be an injustice to fail to point out that many reorganization committees composed of able men devote a great amount of time and effort to their work and sometimes, especially in the smaller reorganizations, give their services without compen- sation. > ^ Even in the latter case, the fees of attorneys for the various reorganization committees must be provided for in the reor- ganization plan. Payments must be made to the managers of the reorganization and to the banks or trust companies which act as depositaries for securities. The receiver's fees, plus the fees of the attorneys who advise with him, are nearly always heavy. And finally, there are numerous incidental expenses and fees for services of accountants, for advertising and cir- cularizing in connection with the reorganization plan, and so forth, which aggregate a large amount. The expenses of reor- ganization are so heavy that it is easy for the members of reorganization committees to persuade themselves that it makes little difference if they include a liberal compensation for them- selves. The self-appointed committee for a certain group of security holders does not always meet with instant acceptance. Security holders are likely to be somewhat skeptical. Unless most of the 1014 CORPORATE FINANCE [Bk. It- large holders are represented in the reorganization committee, they are likely to start an opposition committee and there may be an active struggle for proxies. If the opposition committee is at all successful, there may be later a merger of two committees, for it is clearly essential that there should not be dissension among any one group of security holders. 431. Reorganization Committee In the normal course of events, after several committees have been formed these committees begin to negotiate with each other and with the receiver with a view to arranging the best possible terms for the interests they represent. It is hardly possible for any general agreement to be reached except by a protracted series of negotiations and compromises, and there must be some supreme judge or arbiter. Unless the receiver, some official of the company, or some influential person or bank- ing house can assume this function and really take charge of the whole process of bringing about an agreement, it is natural and customary to select from the various security holders' com- mittees a group which includes at least one representative of each set of interests that must be taken into consideration; this group is customarily known as the "reorganization com- mittee." This is the committee that, in the final analysis, devises the plan of reorganization. The various security, holders' committees may negotiate, but they are likely to follow the lead of their representative on the general reorganization committee and in reality do little more than give their public approval to the final reorganization plan. 432. The Committee Method of Reorganization In spite of its drawbacks, including the ever-present pos- sibility that not all the security holders' committees will conscien- tiously represent the interests entrusted to their care, the com- mittee method of working out a reorganization plan is in most cases the only practical method. In a large corporation meet- Ch. 40] REORGANIZATION 1015 ings of the security holders are quite impracticable; and if they were held they would be utterly useless so far as working out a plan is concerned. The only manner in which they could be advantageous would be in bringing about free and open election of members of the security holders' committees. Even though their work may sometimes be careless, the various security hold- ers' committees, through the general reorganization committee and frequently under the active direction of the banking house that is to handle the underwriting, do eventually agree upon a reorganization plan. On the whole, this method is probably the best that is available. The same idea might be applied more frequently in smaller corporations, the security holders of which cannot effectively express their will. In a recent instance the majority shareholders of an oil-producing company were believed by the minority party to have driven the company into bankruptcy. The sale of its property and assets had been ordered by the Federal Court and a so-called "reorganization committee" composed of former officials was planning to bid for the company at this sale. At the last moment some of the minority shareholders appointed themselves a committee, secured the co-operation of a good proportion of the outstanding shares, employed a capable lawyer and incurred other necessary expenses which did not constitute a heavy burden on any individual shareholder, and presented their objections to the court. These objections were sustained, and in the end the committee forced the adoption of a new and much more equitable plan. In this instance the prompt and courageous action of a few small shareholders checked what probably amounted to a conspiracy to obtain full control of the property. 433. Procedure in Reorganization The first step in a reorganization after some person or group of persons receiver, banking house, reorganization committee, or someone else has been permitted to take charge of the process I0i6 CORPORATE FINANCE [Bk. II- is to bring about a thorough examination and analysis of the .accounts. It may be extremely unsafe to accept without ques- tion the accounting statements issued by the old management, for it is quite likely that their natural effort for several years has been to conceal the company's growing financial weakness. Until the actual earnings and expenses are definitely determined, no practical and really effective plan of reorganization can be worked out. The examination may be both expensive and lengthy. While it is in progress, those actively engaged in the reorganization may carry on negotiations and work out a tenta- tive plan, but no final result can be accomplished. The second step consists of securing an agreement among the various committees. Inasmuch as most of the members of the security holders and reorganization committee are likely to be men of affairs devoting only a relatively small amount of time and thought to the reorganization scheme, these negotiations are troublesome and are likely to cover a long period of time before any definite conclusions are reached. In the meantime, as a third step, the receiver will be conduct- ing the company with all possible economy. Perhaps, as sug- gested in the preceding chapter, he will be raising new capital, reforming the internal organization, and otherwise raising the enterprise to a higher plane of efficiency. If the company. pos- sesses non-essential or non-profit-making property, the receiver may proceed, with the consent of the court, to dispose of some of its property. This, again, may be a long-drawn-out process. The final step, when the reorganization plan has been worked out and accepted both by the security holders and by the court, is to select and put into execution the best legal method of accomplishing the financial rearrangement that has been agreed upon. In case the unanimous, or almost unanimous consent of the security holders has been obtained, the court may declare the plan operative and binding even upon the small proportion that have not given their assent. It is more frequently neces- sary, however, to go through the legal form of organizing a new Ch. 40] REORGANIZATION 1017 corporation- usually with a name very similar to that of the insolvent corporation and to bring about a judicial sale of all the property of the old corporation to the new corporation. The reorganization committee in that case will turn in the obligations of the old corporation in payment for the property, and will issue in exchange obligations and shares of the new corporation under the terms that have been agreed upon. Sometimes stubborn security holders of the old corporation who are opposed to the reorganization plan refuse to exchange their securities for those of the new corporation. The result may not be especially pleasing to them, for they are likely to be left holding securities of a company which is non-active and for all practical purposes may be called non-existent. When the reorganization of the Northern Pacific Railroad Company took place in 1896, the holders of some 25,000 shares refused to ex- change them for shares in the new company, the Northern Pacific Railway Company. The reorganization was completed nevertheless and the 25,000 shares still outstanding are now worthless. CHAPTER XLI ENDS ATTAINED BY REORGANIZATION 434. Raising Additional Capital Methods The general end to be attained by reorganization is of course the rehabilitation of the insolvent concern. The specific pur- poses commonly sought in reorganizations by which this re- habilitation is to be effected are as follows: To raise the additional capital needed for the reorganiza- tion, and the operation of the reorganized company thereafter. To reduce fixed charges. To simplify the financial structure. To give increased facilities for raising any capital that may be needed in the future. To eliminate unprofitable business. To pay or "refund" pressing obligations. To take care of an accumulation of unpaid preferred divi- dends. Usually the most urgent problem in a reorganization is to bring in fresh capital, either for the purpose of making additions and betterments in the fixed assets, or more commonly for the purpose of providing adequate working capital. In either case it is usually necessary to secure a considerable amount of cash. If the company had been well, supplied with cash it would not presumably have become insolvent. But the fact that a com- pany is in receivers' hands is naturally no recommendation to prospective purchasers of its securities, and the problem of rais- ing cash is therefore not only urgent but often extremely difficult. It can be solved only by enforcing drastic sacrifices on security 1018 Ch. 41] ENDS ATTAINED BY REORGANIZATION 1019 holders. There are three possible methods of raising new capital or of securing an equivalent reduction in the outstanding liabil- ities of the reorganized concern : 1. By bringing out new issues of bonds or shares which are well secured and are offered on terms particularly favorable to purchasers. 2. By levying assessments on bond or share holders. 3. By inducing the current creditors, or some of them, to accept funded obligations, or sometimes preferred stock, in payment of the amounts due them. 435. Raising Additional Capital (i) Sale of Securities If the company has any valuable securities of other corpora- tions, these may be sold. However, this source of cash is seldom available, because a failing corporation usually exhausts aU expedients for raising cash before it is forced into a receiver's hands. In case the insolvent company's credit has not already been used to the limit, it may be possible to bring about some rear- rangement of claims upon assets and earnings which will leave room for the issuance of new securities. These securities may then be sold at a heavy discount and thus the urgently needed cash may be obtained. A company which owns an ice and light plant in a small western city was recently in financial difficulties. At the original organization of the company some years before, only about one- half the cost of the plant, which amounted to $43,000, had been secured through the sale of shares; the remaining $21,000 had been borrowed on one-year notes given by the corporation and indorsed by some of the larger shareholders. In subsequent years the company's obligations had been reduced to about $17,000, but the creditors were pressing for payment and the indorsers of the company's notes were reported to be unwilling to renew their indorsements. As a matter of fact, there was a suspicion among some of the minority shareholders that the 1020 CORPORATE FINANCE [Bk. II- larger shareholders were willing to have them ''shaken out," and altogether it was clear that some form of financial readjust- ment was necessary. Inasmuch as the company was earning from $2,000 to $4,000 per annum, with good prospects for a future increase, it was found possible to sell at par a series of one- to ten-year notes, each note for $1,200, bearing 6% interest. This provided $12,- ooo. The remaining $5,000 was obtained by creating an issue of 8% preferred stock, which also was sold at par. Inasmuch as this was purely a local transaction handled by the shareholders themselves, there were practically no reorganization expenses. The common shares were necessarily called upon to make a sacrifice inasmuch as they could not reasonably expect any dividends for a period of some years; but after the payment of the ten-year notes, they presumably will be left with a valu- able property which will yield a high rate of return. In larger and more complex reorganizations, precisely the same principle may frequently be applied. The income of the corporation which may be counted upon with reasonable cer- tainty is taken away from the shareholders and pledged over a period of years to the payment of interest and repayment of principal of a new security issue. However, this plan is possible only on one of two conditions: a residue of unpledged property and income which has not been utilized in the preceding financ- ing, or the drastic scaling down of the claims previously out- standing. The tendency in later reorganizations has been more and more strongly toward severe treatment of the old security holders with a view to providing for an attractive issue that will raise needed capital. 436. (2) Assessment of Security Holders The second method of raising cash is through assessment. In nearly every reorganization the common shareholders are required to pay some assessment in order to secure any holdings in the reorganized company. The same requirement is fre- Ch. 41] ENDS ATTAINED BY REORGANIZATION 1021 quently imposed upon the preferred shareholders and is some- times imposed even upon the junior bondholders. It may seem strange that a bondholder or even a preferred shareholder should be compelled to pay out fresh money in order to hold an interest in the company; but the truth is that any security holder who is not amply protected by marketable assets is likely to face this experience. If he resists the proposal a new company is organ- ized which, at the judicial sale, will turn in the prior lien securities in payment for all the property of the company. This auto- matically wipes out the junior bondholders unless they choose to raise the capital with which to pay off the prior lien holders, in which case they will hold the whip-hand. The junior bond- holders or shareholders are thus left with the clear alternative of either giving up their previous investment without any further effort to protect and redeem it, or of paying the assessment. When the Pere Marquette Railroad was reorganized in 1916- 1917, not only were the three classes of stock, the first preferred, the second preferred, and the common, assessed, but also the two classes of junior bonds. In fact, no distinction was made between the five issues. They were all assessed $9.75 for every $100 par value of the old securities, and in return the owners received $10 par value of new first preferred stock, and in addi- tion a bonus of $20 par value of common stock. In reorganiza- tions of recent years a tendency to treat alike all old issues that are not protected by any equity value, has shown itself. 1 An assessment is an extremely unpleasant thing for the security holder and naturally is accepted only as a last resort. Moreover, it is usually for the best interests of the corporation and therefore for the best interests of the shareholders them- selves in the long run that the assessment method be used. Usually the shareholder who pays the assessment is given at least a nominal equivalent in the form of an increased amount of new stock, and perhaps a certain amount in securities of a higher grade. If he has faith in the company and its manage- 1 Dewing on Finan. Policy of Corp., pp. TIZ-II.J. 1022 CORPORATE FINANCE [Bk. II- ment, he may hopefully look forward to the time when his new securities will be worth full par value. For example, the reor- ganization plan of the Missouri, Kansas and Texas Railway Company, now in process of execution, calls for the payment by the stockholders of $20 per share on preferred stock and $25 a share on common stock. For this the preferred stockholder receives for each 100 shares surrendered, $1,400 Prior Lien Mortgage bonds, Series C, 6%, carrying interest from January i, 1922; $600 Adjustment Mortgage bonds, Series A, 5%, ranking for interest from January i, 1922; and 100 shares common stock. Each common stockholder receives $1,750 Prior Lien Mortgage bonds, Series C, 6%, carrying interest from January i, 1922; $750 Adjustment Mortgage bonds, Series A, 5%, ranking for interest from January i, 1922; and 100 shares of common stock. Another instance of stockholders receiving bonds as well as stock for the assessment paid, is to be found in the reorganiza- tion of the San Francisco Railway Company in 1916. The same assessment of $50 per $100 par value of the old securities was imposed on the first preferred, the second preferred, and the common stock, and for their payment the shareholders obtained $50 par value of a prior lien bond and a common stock bonus. In the distribution of the bonus some regard was paid to the relative position of the three classes of shares the first preferred receiving $100 par value of the new common stock, the second preferred $90, and the old common $82. Probably the most drastic assessment on record is that of the Houston and Texas Central Railroad Company in 1897, which amounted to 73% on the common shares. Regardless of the amount of the assessment, however, the question as to whether a shareholder should or should not pay, is always one to be studied with much care. Naturally the reor- ganization managers will make terms that will be at least fairly attractive in order to make certain that the money which is required shall be forthcoming. For this reason it is usually profitable for shareholders to pay up their assessment. Ct. 41] ENDS ATTAINED BY REORGANIZATION It is stated that in almost all cases of railroad reorganization the price of the securities obtained by payment of the assess- ment was, within six months thereafter, nearly equal to the previous market quotation plus the assessment. In practically every case later quotations have gone much higher. The in- crease in value "has abundantly justified the payments which stockholders were asked to make." 437- (3) Funding Floating Debt The third method of increasing cash resources that of in- ducing the current creditors to accept long-term securities in settlement of their claims is practicable only when the insolvent company is fundamentally prosperous and has been brought into difficulties merely through a temporary shortage in working capital. In both the Westinghousc reorganizations the holders of floating debt were persuaded to take long-term notes and bonds in payment, for they were convinced of the company's inherent soundness. In the first reorganization of 1891, the company's $3,000,000 in floating debts were replaced largely by stock issues. In the reorganization of the Goodyear Tire and Rubber Company, in 1921, the merchandise creditors received 125% of the amounts due them on January i of that year for merchandise actually delivered in prior preference 8% cumulative stock; while in the case of commitments for merchandise not delivered prior to January i, 1921, but for which specifications and prices had been fixed on that date, they received 75% in cash and 28% in preference shares. 438. Reorganization Underwriting Syndicate In every reorganization where it is proposed to raise cash, whether by assessment or by the sale of new securities, the serv- ice of an underwriting syndicate of bankers is indispensable for the successful execution of the general reorganization plan. Security holders are not obliged to pay the assessment if any is 1024 CORPORATE FINANCE [Bk. II- levied. If the market value of their holdings is nominal and far below the amount of the proposed assessment, many of them may decline to throw good money after bad, as the proceeding may appear to them. The company has therefore no means of knowing what response it will get from those subject to the as- sessment; and as it must be in possession of the required amount of cash if the entire reorganization scheme is not to miscarry, a banking syndicate is formed to underwrite the assessment. In substance, a syndicate of this nature, for a commission, obligates itself to pay the assessment of all defaulting security holders and to take over the securities assigned to them in the new corporation. If the expedient resorted to for obtaining cash is the sale of new securities, the syndicate purchases the issue on some agreed basis, precisely as it would if the company were solvent and were doing a piece of normal financing. The payment received by the underwriting syndicate nat- urally varies with the conditions. In the Missouri, Kansas and Texas reorganization referred to above, the underwriting syndi- cate "is to receive a commission of 5% on the aggregate syndi- cate obligation, and $1.50 per share for so much of the common stock of the new company so offered to stockholders under the plan as such syndicate shall take and pay for." , 439. Reducing Fixed Charges In the majority of cases of insolvency the trouble has arisen primarily because the company had a larger load of fixed charges than its income would permit it to carry. That being the case, the only safe and correct course in reorganization is to cut down these charges. It. is useless to continue them unless the com- pany's difficulties are partly temporary; for to do so would be simply to invite a new insolvency. One of the simplest and most severe cases of cutting down fixed charges was that of the reorganization of the Northern Pacific Railroad Company in 1875. The company's line was at that time still under construction and its earnings were less than Ch. 41] ENDS ATTAINED BY REORGANIZATION 1025 l /2 of i% on its funded debt. There seemed to be no immediate prospect of increasing the earnings and it was therefore deter- mined that all fixed charges should be eliminated. All outstand- ing bonds were replaced by preferred shares; floating debt was also exchanged for preferred shares; and old common shares were replaced by new common shares. It is pointed out that out of seven railroad reorganizations in the period from 1893 to 1898, every one showed a decrease in fixed charges averaging 31%. In practice, experience shows the advisability of keeping in view, in the rearrangement of fixed charges, the five following principles: 1. The maximum fixed charges after reorganization should not exceed the absolute minimum of net earnings. 2. As large a proportion as possible of the charges should consist of interest on bonds. Sinking funds with their requirements, guaranteed dividends, rentals, and the like, should be avoided as much as possible. 3. The losses should fall most heavily on the junior security holders generally, leaving the first lien securities unless the reorganization is exceedingly drastic practically untouched. 4. The nominal value of the new securities received by security holders in the old company should be reduced as little as possible. 5. Bondholders whose claims are scaled down should be given an opportunity to participate in any future increases of earnings. 2 If the junior bondholder who is asked to accept a reduction in the principal and possibly in the rate of interest of his holdings, is at the same time given preferred and common shares up to the full par value of his former bondholdings, or perhaps a little above, he is inclined to accept the reduction much more readily. He may feel, quite properly, that there is' at least a chance of his recovering in future all the capital that he has lost. 2 Daggett's Railroad Reorganization, pp. 357-362. 1026 CORPORATE FINANCE [Bk. II- As to industrial reorganizations, the results of 27 companies show that fixed charges were reduced on the average about 25%. 3 This percentage probably measures fairly well, the excessive amounts of bonded and other obligations which were issued above the limits of prudence under the old financial plan. 440. Trend of Reorganization Procedure The tendency on the whole has been more and more strongly toward avoiding half-way measures in reorganizations and toward putting the corporation on its feet financially so that it will not within a short time come back into the hands of the financial surgeons. To illustrate this tendency, an interesting parallel may be drawn between the first reorganization of the Erie Railroad in 1859 and its reorganization in 1895, by which time the present-day methods and principles of reorganization had become well recognized. In the first reorganization fixed charges were not reduced, preferred shares were given in exchange for the unsecured indebtedness, the second mortgage which was about to fall due was extended, and an assessment of 2^/2% was levied on both preferred and common shares. The position of the road was not much stronger after the reorganization than it had been before, and the money paid in by the shareholders was dissipated without permanent benefit either to the corporation or to them- selves. The reorganization of 1895, on the other hand, lowered fixed charges, procured ample cash by assessments on the share- holders, and gave shares rather than bonds in exchange for the new cash that was raised. 441. Effect on Financial Structure One customary result of reorganization is an increase in capitalization. At first glance this may seem surprising, but it is the necessary result of the policy of compensating the old security holders for their sacrifices by giving them some form of claim on the future earnings of the corporation. Junior bondholders are 3 Dewing on 'Corp. Prom. & Reorg., p. oil. Ch. 41] ENDS ATTAINED BY REORGANIZATION 1027 usually asked to accept a percentage of new bonds plus a per- centage of preferred shares, the new securities having a total nominal value at least equivalent to the nominal value of the bonds they formerly held. The preferred shareholder is perhaps asked to pay an assessment and accept new securities consisting of preferred and common shares. The common shares may be reduced or wiped out, but more often, upon payment of assess- ment, are replaced by shares of not greatly reduced nominal value. In general, the tendency is strongly toward reducing bond capitalization and increasing the share capitalization more than proportionately. 442. Simplification of Financial Structure Another customary result of reorganization in large corpora- tions is the simplification of the company's financial structure. In the years preceding reorganization the company has in all probability put out various issues of bonds, preferred shares, and common shares, some of which may have conflicting or uncertain claims. Reorganization gives an opportunity to replace these various small issues by a few large issues. At the same time, increased facilities for raising capital in future are often provided. The new issues are made large enough to pro- vide for the immediate needs of the reorganized company, with the proviso that additional bonds may be sold under the same mortgage on fulfillment of the conditions of the deed of trust. Through this simplification and provision for future capital requirements,- the company's financial structure may be brought into line with the best present-day practice. This is often one great advantage of reorganization. 443. Elimination of Unprofitable Business Another advantage frequently afforded by a reorganization is the opportunity to eliminate unprofitable branches or depart- ments. Sometimes the bondholders who are secured by a mort- gage or a branch or an isolated plant are bluntly told that they 1028 CORPORATE FINANCE [Bk. II- may take the property which is not wanted by the parent corpora- tion. More often, the fact that the property to which they have a claim is not essential, is driven home and they are forced to agree to a considerable reduction in their claims, which may be sufficient to put the outlying branch or plant on a profitable basis. Reorganization is apt to be carried on in a cold-blooded way by financial men who are impressed only with results that have actually been achieved. Frequently the main difficulty with a business that has become insolvent has been over- optimism and over-expansion on the part of its management. Wherever that is the case, a reorganization which eliminates these outside ventures or reduces the expense of conducting them may and in practice not infrequently does prove of great and lasting benefit to the corporation. 444. The Claflin Reorganization As an interesting illustration of some of the principles above discussed, we may take up briefly the history of the failure and reorganization in 1914 of the great wholesale dry goods house of H. B. Claflin Company. This company was organized in 1843. After a long period of prosperity the firm began to feel the effects of severe competition from jobbing houses in western trade- centers, and in order to meet this competition it began to build up its own retail outlets. Through certain controlled companies, particularly the Associat- ed Merchants Company and the United Dry Goods Company, 35 well-known department stores in various important cities were brought under the control of the Claflin interests. These stores naturally purchased most of their goods through the H. B. Claflin Company. It is questionable whether the close relationship thus estab- lished between a wholesale house and retail stores was really valuable to either party. Of course, it enabled the H. B. Claflin Company to carry on extensive operations for a long period ; but its apparent size and prosperity turned out to be largely artificial Ch. 41] ENDS ATTAINED BY REORGANIZATION 1029 and unsound. So far as the retail stores were concerned, it was evidently of no advantage to them to be compelled to purchase most of their supplies from a given wholesale establishment. When the failure was, first reported it was thought that the total Claflin liabilities amounted to about $34,000,000, but it soon became evident that large amounts of notes had been issued and obligations incurred of which there was no clear record. The relationships of the many companies included in the combina- tion had become so involved that it was months before the receivers could obtain even the approximate amount of the liabilities; and in the end the total liabilities were placed at about $45,000,000. It was found that the financial transactions of all the various department stores were being handled in New York, and that the active managers of these stores knew nothing about many of the liabilities which the treasurer of their company, sitting in his New York office, had created. For instance, the Hennessy Corporation, which operated stores in Butte and Anaconda, Montana, had on' its books obligations amounting to only $83,000. The president of this company had no knowledge whatever of the existence of any other obligations; but he was suddenly advised after the receivership of the Claflin Company that approximately $1,700,000 in notes of the Hennessy Corpora- tion had been issued and after having been indorsed by the Claflin Company, were discounted in New York. The same practice was followed with subsidiary companies all over the country. In this way an enormous amount of "accommodation" paper was put out. The parent company's contingent liability on this paper, however, was not shown in the financial statements it had submitted to bankers and to those who bought its com- mercial paper through note-brokers. The scheme of reorganization finally agreed upon was based upon the idea that the wholesale business and the retail business of the combination ought to be separated. The Dry Goods Economist pointed out that, while the day has gone when a 1030 CORPORATE FINANCE [Bk. II- general jobbing house located in New York could do a great national business, there was still an important field open to the H. B. Claflin Company in handling business within a short distance of New York. ^ .; <. The plan for reorganization provided that the noteholders receive in exchange for their old notes 15% in cash and 85% in three-year collateral-trust income notes issued by the new company which was to be known as the Mercantile Stores Corporation. The Mercantile Stores Corporation was to own all the stock of the insolvent department stores in the combina- tion, and turn these into cash as rapidly as possible. It was also provided that a new company, known as the H. B. Claflin Cor- poration, should continue that portion of the wholesale business which had proven profitable. All the stock of the H. B. Claflin Corporation was to be owned by the Mercantile Stores Cor- poration. Under this plan the new corporations were enabled to begin their operations without any current indebtedness. The plan of reorganization was somewhat unusual in that it did not call for any new capital and at the same time freed the subsidiary corporations from current liabilities. As far as the old stockholders of the H. B. Claflin Company were concerned, nothing was ever realized. The Mercantile Stores Corporation, however, distributed over $17,000,000 in cash to the creditors of the old company, and then having carried its liquidation of assets as far as could be done without unjustifiable losses, was reorganized in 1919 as an operating company under the title of Mercantile Stores Company, Inc. The H. B. Claflin Corporation was purchased in 1917 by, and merged with, Claflins, Inc. BOOK III CORPORATE ACCOUNTING Part I Surplus and Reserve Accounts CHAPTER I THE CORPORATE RECORDS AND ACCOUNTS i. Corporate Accounts Strictly speaking, there are no books of account, nor are there entries on books of account, which are absolutely peculiar to corporations. Most of the books and accounts used will be found in any business of similar nature conducted under any other form of business organization. When we come to the more dis- tinctively corporate accounts, we find that the joint-stock com- pany also employs these same accounts. But the joint-stock company as a form of business organization is so nearly obsolete that it may be ignored, and the capital stock and dividend records may be considered as being distinctly corporate, to- gether with the entries covering dividends and transactions in capital stock. There are also certain transactions, such as those dealing with bonds, which, while not necessarily limited to corporations, occur rarely in other forms of business and are commonly thought of as being distinctive of the corporation. Many transactions encountered in corporate books admit of more than one manner of treatment. In the following chapters it will be found that transactions identical in nature have been variously handled for purposes of exemplifying these different methods. In this connection it should be noted that in some cases there is a diversity of opinion as to the entries and names of accounts that are best employed under the varying 1033 1034 CORPORATE ACCOUNTING [Bk. III- conditions that confront the corporation accountant. In each case, however, that plan which will best provide all of the infor- mation desired with the fewest possible repetitions and least chance of confusion, has been used in the present volume. 2. Requirements of Corporate Records As stated, the general books dealing with the ordinary com- mercial transactions of a corporation differ not 'at all from those of a partnership or a single proprietorship conducting a similar line of business, and for their character and use the reader is referred to any text on accounting. In a corporation, however, there is, in addition to the books of account which record the transactions of ordinary business, another class of books, such as the minute book, stock book, dividend book, bond record, etc., for recording the activities which are almost peculiar to the corporate form. So necessary are these books that in many states the laws specify that certain of them, as the minute book, stock book, transfer book, etc., shall be kept. 1 Some of these are not accounting records, but all of them which are accounting records and are peculiar to corporations are discussed in subse- quent chapters. 3. Choice of Corporate Records The distinctive books of record to be kept by a corporation are frequently set forth in its by-laws; although the books so enumerated would usually be kept as a matter of course by any well-managed corporation. Under these conditions the accountant, when devising an accounting system for a corporation, must first consult the statutes of the state to ascertain the legal requirements. Fre- quently the statutes not only prescribe certain books, but also specify where these books must be kept and what they must contain. Next he must consult the by-laws of the corporation 1 For a discussion of the minute book see Book I, Part IX, "Meetings and Records"; also Book IV, Ch. XVI, "Minutes of Corporate Meetings," Ch. i] CORPORATE RECORDS AND ACCOUNTS 1035 to ascertain their requirements as to books and records. Then, in addition to the books required by the laws and the corporation by-laws, he must add such other books as are needed to make a complete record of the financial transactions of the corporation. The usual corporate records include : 2 Minute book Subscription records Instalment receipts Instalment book Stock certificate book Stock transfer book Register of transfers Stock ledger Dividend book . Bond register This number might be extended considerably, and subdi- visions made, especially in the case of large corporations. On the other hand, in the case of a small company some of the enum- erated books would be omitted entirely. Indeed, in some companies, especially where the stock is held by a few individuals, the bookkeeping is as informal as in a partnership and but few of the distinctive corporate records are' kept. It is, however, a wise precaution always to provide for the proper record of all corporate transactions, no matter how small the corporation or how closely its stock may be held. If this is not done, trouble may result, and "an ounce of prevention is worth a pound of cure." All the books enumerated above are auxiliary books sub- ordinate to the general books. Many of them are subsidiary ledgers, by which it is meant that they contain the detailed accounts with individuals or things, only the grand total of whose balances appears on the general ledger. * From the accounting standpoint these records are discussed in later chapters of the Book I, "Corporate Law"; their forms will ex and list of forms for specific references. present book; from the technical standpoint in Book I, "Corp9rate Law"; their forms will be found in Book IV, "Corporate Forms' ; see indi 1036 CORPORATE ACCOUNTING [Bk. III- A book known as a "combination record" is frequently used by the smaller corporations for the distinctive corporate records. This book is divided into parts, each of which takes the place of the more important of the distinctive corporate records men- tioned above. If the forms included in it are good, the combina- tion record will be found convenient for the ordinary small corporation. For the larger corporation it is not suitable 4. The Net Worth Accounts It is in the accounts which represent the proprietorship, capital, or net worth of the corporation that the greatest dif- ference from the accounts of other forms of business organiza- tions is found. In an individual proprietorship or a partnership the investment consists of the cash or property contributed by the proprietor or by the partners. In a corporation it consists of the proceeds of the stock sold. The investment of a sole proprietor, or of partners, plus the amount of profits left in the business is represented by the capital accounts; while only the investment of stockholders is represented by the capital stock accounts, the undivided profits being carried in a separate account. Even then it is not always true that the original investment is represented by the capital stock accounts, for if in a corpora- tion with par value shares the stockholders contribute more or less than par, the difference is considered as a form of paid-in surplus or as a discount on stock a reduction of surplus. Whether the shares are with or without par value, the number of shares owned by each stockholder, as shown by his account on the corporate stock ledger at any particular time, represents his proportionate interest rather than his property interest. 3 In a partnership the profits are usually credited to the pro- prietors' accounts and remain there until drawn out according to agreement, but the profits of a corporation are credited once But see discussion of rights attached to preferred stock, Book I. Ch. XI, "Preferred Stock." Ch. i] CORPORATE RECORDS AND ACCOUNTS 1037 a year or oftener to Surplus and never to the accounts of the individual stockholders until a dividend is declared. In fact, only close corporations with but few stockholders have general ledger accounts with their individual stockholders. The capital accounts of the proprietor or partners represent the book value of the net assets, but the capital stock accounts of the corporation represent, in the case of the corporation with no-par-value stock, the amount received by the corporation for its capital stock; and in the case of the corporation with par- value shares, only an arbitrary figure dependent on nothing but the par value of the outstanding stock, the difference between this figure and the value of the net assets (whether due to profit or loss, to donated capital and withdrawals of capital, or to appreciation) being carried in the Surplus account. The place of the proprietorship accounts of the individual or partnership is taken in corporation accounting by two groups of accounts known as the "net worth accounts" because their total represents the book value of the net assets (gross assets less liabilities), or the net worth of the corporation. These two groups are the capital stock accounts 4 and the surplus account or accounts. 5 4 See Part II, "The Original Capital of the Corporation." 5 See Ch. II, "The Surplus Account." CHAPTER II THE SURPLUS ACCOUNT 5. Nature of Surplus The surplus account usually contains all those profits that are not reserved for some special purpose. Or, more broadly, it is the account in which is entered all excess of assets over lia- bilities except any of that excess which Jias been set aside so as to be unavailable for dividends. In the balance sheet it is represented by the excess of assets over liabilities and capital. Surplus is, then, a general term used to represent the differ- ence between the net worth of a corporation and, in the case of a corporation with par-value shares, the par value of its out- standing stock, or, in the case of a corporation with no-par-value stock, the amount received for its stock. Such a surplus may arise in several ways. It may result from profits on ordinary operations or unusual transactions, or from donations to the corporation, or it may be brought about by increasing the book values of the assets above their cost. In the case of corporations with shares of a specific par value, the surplus may be the result of sales of stock at more than par. A surplus so built up may be reduced in any of the opposite ways: by selling a corporation's own stock below par; by losses, whether from operations or casualty or unusual trans- actions; by donations by the corporation; by writing down the book values of assets; or by distributions of the profits among the stockholders (dividends). 6. Analysis of the Surplus Account A large surplus is the pride of every well-managed corpora- tion, and especially of banking institutions in which the surplus 1038 Ch. 2] THE SURPLUS ACCOUNT 1039 is frequently larger than the capital stock itself. Where a sur- plus exists, it is usually maintained as a measure of safety to strengthen the financial condition of the company and to safe- guard it against unforeseen contingencies. SURPLUS Debit: At the close of each fiscal period, with the net loss, if any, as shown by the Profit and Loss account. 1 With any adjustment during the fiscal period which diminishes the profits of a previous fiscal period. 2 With the amount of extraneous or unusual losses. 3 With amounts set aside so as not to be available for dividends. 4 With the discount on the sale of the corporation's capital stock. 6 With amounts by which the book values of assets are decreased other than through wear and tear. With the amounts of dividends declared. 9 Credit: . At the close of each fiscal period, with the net profit, if any, .as shown by the Profit and Loss account. 1 With any adjustments made during a fiscal period which should have been credited to some profit and loss account within a prior fiscal period; or which increase the profits of a prior fiscal period. 2 With the amount of extraneous or unusual profits. 3 With amounts previously set aside as not available for dividends, and no ,v returned to the general surplus. 5 With the premiums received on the sale of the corporation's capital stock. 7 With amounts by which the book value of fixed assets is increased. 8 With amounts of donations to the corporation. 10 Surplus account may be credited with the year's net profit before the dividend is declared, or with the portion of profits to be retained in the business after payment of dividends. Dividends are usually not declared until the amount of net profit is known, unless the unapportioned surplus is ample to cover any shortage that might result; to do otherwise might result in wiping out the surplus already created. 1 See 5 22. 2 See | 7. See I 8. See Ch. III. tiee f 17. See Ch. VIII. 7 See I J 23, 24, 25; also Ch. VIII. 8 See }{ 26 and 27. ' See Ch. XIV. "See || 28, 99; also Ch. X. 1040 CORPORATE ACCOUNTING [Bk. III- Surplus is an increment of capital. When added to the balance of the capital stock accounts, the sum total should represent the net worth of the business. Surplus account may even show a debit balance as a result of business depression, heavy losses, or payment of excessive dividends. In that case such deficit represents a loss and a capital impairment. The Surplus account is frequently entitled "Surplus and Deficit" account, in order that it may, without misnomer, not only accommodate surplus but any deficiency as well. This is the plan used by public service commissions in their schedules and reports. The account is credited with surplus profits and charged with such net loss as may result in any year. A debit excess of this account, of course, represents a deficiency or impairment of capital, while a credit excess is the opposite. 7. Adjustments of Profits of Previous Years In closing the books of a personally owned business, the profits of the period are credited to the account of a sole pro- prietor or divided between the accounts of partners. In closing the books of a corporation, the nominal accounts are first closed into Profit and Loss account and the resulting balance in the Profit and Loss account is closed into Surplus account. By thus closing the nominal accounts they will in any period show only items which affect the gain of that period. But after the books are closed corrections are often found necessary or omissions are discovered. These may affect the profit of the previous period. In order that the adjustments of these may not wrongfully affect the profit of the new period, they must not be allowed to appear in the newly reopened nominal accounts. The corrections, then, instead of being en- tered to the nominal accounts, are made directly to the Surplus account as adjustments of the amount of profit or loss previ- ously carried to that account, thus preventing them from affect- ing profits of the current year by keeping them out of the nomi- nal account of the current year. Ch. 2] THE SURPLUS ACCOUNT 1041 For example, if an invoice of $547.50 for merchandise pur- chased in December, 1921, was erroneously entered Merchandise Purchases $574 . 50 To Accounts Payable $574 . 50 and the error was discovered in January after an annual closing, the correction, instead of being made by the usual entry Accounts Payable $27 .00 To Merchandise Purchases '.U'i $27.00 would be -made by the entry Accounts Payable $27 . oo To Surplus &.-B. $27.00 This would indicate an increase of $27 in the profit for the pre- ceding year, cost of sales being reduced by that amount. In the above exposition it is assumed that the closing inven- tory was correct. If it was not, the rule would still apply that the amount by which the profit of the preceding year is affected should be entered directly to Surplus. If the adjustments found necessary are few in number and small in amount, there is no great objection to letting them appear as factors in the current Profit and Loss account. But errors that are of any importance should be adjusted through Surplus, so that exact statements of the transactions of previous years may be prepared by re- casting the previous statements and exact comparisons be made between the operations of various years. It is evident that omissions and errors in showing the trans- actions of previous years affected the final net credit to Surplus in the years in which they occurred. It therefore follows that the present surplus is larger or smaller as a result, and that Surplus is the account to be corrected. 8. Extraordinary Gains and Losses The practice is common of entering directly to Surplus account any extraordinary gains and losses whose inclusion in the current Profit and Loss account would render the resulting total of that account useless for purposes of comparison between 1042 CORPORATE ACCOUNTING [Bk. III- various periods. Under this practice the Profit and Loss account is limited to use as a clearing account for the normal items of income and expense, all abnormal charges and credits to pro- prietorship being made directly to Surplus. There may thus be entered direct to Surplus any gains or losses which are not the result of the regular normal operation of the business. In this category will be found such items as losses by fire and gains or losses from sales of fixed assets. The function of the Profit and Loss account is held to be the collection of the items affecting the normal operations of the business. If a concern not in the real estate business credits Profit and Loss with the gain resulting from the sale of a factory site, it destroys the basis of comparison between the profits of different years. The objection is raised against this practice, that the habit of using the Surplus account for such purposes as this may re- sult in its becoming abused by being turned into a dumping ground like the proverbial General Expense account. While the wrqngful use of an account does not furnish sufficient ground for not sanctioning a legitimate use, yet, because also of the added reasons given in the next section, the Surplus account should be used only with the greatest discretion for entries of this type. In any event the extraneous and unusual items can be shown in. a separate section of the profit and loss statement after operating profits have been determined. 9. Federal Income Tax and the Surplus Account The federal income tax laws and forms have had a marked influence on accountancy. One feature in which their influence has been noticed is in bringing into considerable disfavor the practice of charging directly to Surplus any items of gain or loss applicable to the current period. The changed policy in this regard is due not to anything in the laws themselves but to the form of reconciliation or proof of Profit and Loss and Surplus required to be filled out as a Ch. 2] THE SURPLUS ACCOUNT 1043 part of the corporation income tax return. 11 A condensation of this form is given below with the subclassifications eliminated. Net taxable income $ 43,271.10 Non-taxable income: Interest on Liberty bonds 44.00 Other items . . none \ Total $ 43,315.10 Unallowable deductions: Donations $ 160.00 Income and profits taxes paid 12,362.64 Other items . . none Total 12,522.64 Net profit by books $ 30,792.46 Surplus at beginning of year 122,360.62 Credits to Surplus during year none Dividends paid '. $20,000.00 Other debits to Surplus none Total 20,000.00 Surplus at close of year .' $133,153.08 From this it will be seen that it is the expectation of the Bureau of Internal Revenue that all items affecting profit of the year (income whether taxable or not, and losses whether de- ductible or not) will be handled through the Profit and Loss account, so that the book profit may be proved by adding back to the taxable income those items of income which are not taxable (such as certain interest on Liberty bonds) and sub- tracting those expenses (such as donations) which are not de- ductible. The form of this schedule has had, as stated, a ten- dency to reduce the number of charges made directly to Surplus, because an awkward adjustment is necessary if extraneous and See Ch. XXXVI, "Federal Income Tax Returns." 1044 CORPORATE ACCOUNTING [Bk. Ill- unusual gains and losses are handled directly through Surplus account. When such items are entered through the regular Profit and Loss account, however, they should invariably be shown as unusual items in a separate section of any profit and loss state- ment which may be prepared, in order that the profit made through normal operations may stand out by itself for compara- tive purposes. 10. Entry of Federal Income and Profit Taxes The best accounting practice calls for the entry of federal in- come and profit taxes as a charge against the profits of the year against which they apply. In no way can they be considered as an expense of the year in which they are paid. The failure to recognize this latter fact has been the cause of many of the objections against the "injustice" of the income tax laws. All public accountants have had cases similar to that shown by the following example : A corporation's profit for the calendar year 1918 was $200,000; the amount of tax assessed on this profit was $130,000. The next year, 1919, showed a book loss of $30,000, the $130,000 of tax paid on the income of 1918 having been charged as an expense in 1919. There was therefore a taxable profit of $100,000 in 1919, since the amount of the in- come tax paid may not be taken as a deduction in determining the amount of taxable profit. The tax on this amount was $40,000. The president of the corporation expressed himself rather vigorously about having to pay an income tax on a loss, and also said: "They tax you on your income and then tax you on the tax you pay." If in his own mind he had applied the tax of $130,- ooo paid in 1919 against the profits of 1918, reducing them to $70,000, and had applied the tax payable in 1920 against the profits of 1919, reducing them from $100,000 to $60,000, he would have seen that his point of view was unfair, although of course this particular corporation was in a high tax class. Ch. 2] THE SURPLUS ACCOUNT 1045 It is wise, whenever possible, to determine the amount of in- come tax liability at the time of closing the books, and to charge this amount either to Surplus or to Profit and Loss for the period, entering of course the offsetting liability. This procedure would not have been so heartily recommended before the passage of the 1921 Revenue Act, because of the adjustments necessary in computing invested capital. This objection no longer applies. In regard to making a choice between the Profit and Loss account and Surplus account, accountants are still somewhat dis- agreed, with the weight of authority in favor of making the entry to Surplus. For this stand it is argued that the income tax is not a charge against the profit, for one if not both of the following reasons: (i) it is an extraneous item determined after the profit is ascertained; and (2) it is a distribution of profits after they are made, somewhat in the nature of a dividend. Those who prefer to charge the tax to Profit and Loss have also two arguments, viz. : (i) that it is no more an extraneous item than is a bonus which is based on the amount of net profits and which consequently cannot be determined until the amount of the profit has been ascertained; and (2) that Schedule "L" of the income tax return is more easily prepared if the disbursement is charged against profit on the books, and re-added as an unal- lowable deduction on the schedule. The credit should be to Accrued Taxes, and the entry to set up the amount of tax payable on the income of the year whose accounts are being closed, will be : Profit and Loss, or Surplus $1,000 To Accrued Taxes $1,000 Amount of federal income tax payable on profit shown by above closing. ii. Surplus Does Not Represent Specific Assets While surplus is always represented by an equivalent of assets, these assets as a rule are not earmarked or designated in any way. It is simply the excess of assets over liabilities and capital stock, and does not represent any specific assets. 1046 CORPORATE ACCOUNTING [Bk. III- It is a common practice for corporations to invest part of their surplus cash in gilt-edged securities, such as bonds and stocks of other companies. This insures the company against danger of being without liquid funds in case of a crisis; but, on the other hand, when the low rate of return from these securities is consid- ered, it is manifest that the money "thus invested could be used more profitably in the business. Most corporations, neverthe- less, follow the practice of investing in such securities, knowing that they can be used at any time as collateral for securing bank loans or be readily sold on the stock exchange. Such outside investments may, but generally do not, repre- sent all of surplus profits, but in any case it should be remembered that it is the surplus cash (cash not needed for immediate pur- ^poses) and not the surplus shown by the Surplus account which is being invested. CHAPTER III RESERVE ACCOUNTS 12. Withholding Surplus from Dividends Surplus fundamentally represents the amount which is under the direct control of the board of directors for purposes of declar- ing dividends. To this rule there are, of course, certain exceptions created by law or established by contract, such as those whereby reserves for the redemption of bond issues are required to be set aside out of earnings. With these exceptions, boards of directors have practically free control over the surplus. They may set aside certain portions of it for specific purposes, as for new equip- ment, for contingencies, or for other purposes, thus impounding or appropriating those portions of the surplus and rendering them not available for dividend purposes. But the fact that a board of directors has set aside a certain amount of the profits for a specific purpose does not guarantee that the amount set aside will be so used, for the board may at a later date vote to turn back this reserve into the general surplus. The impounding of surplus is, therefore, often more apparent than real, because, unless other persons are definitely a party thereto, the board may reverse its action. Many business men are under the impression that the very term "surplus" involves a certain limitation of distribution. There are those who separate surplus into two items on the bal- ance sheet, one called "undivided profits" or a similar name and the other called "surplus." This is intended to convey the idea that the item designated as surplus is intended to be retained in the business, and that the giving of the name surplus is public notice of such intention. But the term surplus is used in such a 1047 1048 CORPORATE ACCOUNTING [Bk. Ill- variety of ways that it may not give to the observer any such idea.i If the balance sheet of a corporation shows a large surplus, on the strength of which the corporation borrows money, there is nothing to keep it from immediately thereafter greatly reducing this surplus through dividends. It makes no difference whether the surplus is shown as appropriated for specific purposes or not. While it might be held that the directors declaring dividends im- mediately thereafter have deceived the lenders of the money, they are technically within the*ir rights. On this account it might seem desirable to adopt a more definite terminology for the funds intended to be withheld from dividends -a designation so specific that its mere use would be a pledge on the part of the directors that the funds so earmarked were to be retained for the use of the business. Such a definite appropriation of surplus might, on the other hand, sometimes prove harmful. Occasion might arise when the corporation's credit would be impaired, and consequently the creditors' rights endangered, unless dividends should continue to be paid with regularity. But it might be that dividends could not be paid without encroaching upon surplus which, although legally available for distribution, had been appropriated for other purposes at some preceding date. 13. Entries for Appropriation of Surplus When it is thought to be desirable to reserve a certain amount of surplus at least temporarily from distribution in dividends, an entry should be made debiting Surplus and crediting the proper reserve account. Such accounts may be called Reserve for Sink- ing Fund, or Reserve for Contingencies, or Reserve for Improve- ments, or Preferred Stock Redemption Reserve, depending on their purpose. The entry would be made in the following manner: ' See f ax. Ch. 3] RESERVE ACCOUNTS 1049 Surplus $50,000 To Reserve for Improvements '. $50,000 To remove from the general Surplus the above sum, setting it aside as a reserve out of which it is planned to make certain improvements, as directed by the Board of Directors, January 3, 1922. Some accountants, in closing a set of books, prefer to estab- lish or increase the reserve directly out of the year's profits in- stead of first closing those profits into Surplus. The one practice would require two entries as follows: Profit and Loss $40,000 To Surplus $40,000 To close Profit and Loss account of year to Surplus. Surplus $10,000 To Reserve for Bond Redemption ; ."' ' $10,000 To set aside from surplus a reserve for redemption of bonds, as ordered by the Board of Directors. The second method needs only the single entry: Profit and Loss $40,000 To Reserve for Bond Redemption V; ' $ro,ooo Surplus 30,000 To set aside out of the net profits of the year the amount ordered by the Board of Directors to be withheld toward redeeming the bond issue, and to close the remainder of the profits into Surplus as available for dividends. In making the entry in this form it must not be thought that the charge to Profit and Loss for the amount placed in the Re- serve for Bond Redemption is of the same nature as ordinary charges which reduce the amount of net profit for the period. This charge is not a reduction of the profits of the year; it is m-ade to Profit and Loss merely as an appropriation of this par- ticular year's profits, just as the charge when made to Surplus is an allocation of the undivided profits in general. 14. Reserves Which Are Chargeable Against Profits ' ! ' ' On the other hand, it must not be thought that all reserves are established out of profits already ascertained. There is a 1050 CORPORATE ACCOUNTING [Bk. III- class of reserves which are direct charges against the profits of the period, and while the discussion of them is a matter of gen- eral accounting interest rather than one of corporate procedure solely, yet the distinction must be presented for the sake of clarity. Any reserve which, like those discussed in the previous sec- tions, is an appropriation or impounding of surplus, is a non- operating reserve. Such reserves are not necessitated by ex- penses and do not indicate a deduction from profits. They are set up solely to show the amount of realized profits which have been set aside for some purpose such as the construction of a new building or improvements, the paying off of a bond issue, etc. If definite assets are set aside for these purposes, such assets become part of a fund. The fund itself is an asset; the reserve is a setting aside of surplus, and appears on the liability side of the balance sheet. 2 Operating reserves, however, are made up of amounts set up to show some expense not expenditure which must be entered before the net profits can be determined. The prudent business man, being careful not to overstate his profits, makes, through operating reserves, allowances to meet expected losses or those incurred but indefinite in amount. Examples of this type of re- serves are reserves for bad debts, for depreciation, for discounts to be taken by customers, for taxes, etc. For instance, it is a well-known fact that customers' accounts are in part frequently uncollectible, and experience has shown the advisability of mak-. ing due allowance for such losses. 15. Operating Reserves Represent Expenses The debits offsetting the credits to operating reserves are 'to expense accounts, and the entries cover expenses of two classes: The first class consists of expenses which have occurred through the reduction of the value of assets. In this case the re- serve account is used when it is desired not to reduce the book 2 See also $ 215. Ch. 3] RESERVE ACCOUNTS 1051 valuation of the assets by writing off the proper amount, as for example the writing down of the cost of machinery by a credit to Reserve for Depreciation instead of to the Machinery account itself, or the writing down of the total accounts receivable by a credit to Reserve for Doubtful Accounts instead of to Accounts Receivable, as would be done if specific accounts were definitely written off. Such reserves as these are preferably called "allow- ances," in order to lessen the confusion which has arisen from the different uses to which the so-called "reserve" accounts are put. Some authorities place much stress on this distinction, speaking very strongly in favor of the titles "Allowance for De- preciation," "Allowance for Doubtful Accounts," etc. The second class consists of expenses which have occurred through the establishment of a liability, as a reserve for taxes or for royalties. In the case of most operating reserves set up to indicate a liability, the account is better distinguished by the term "accrued," as Accrued Taxes or Accrued Royalties. The use of the term "reserve" in connection with the oper- ating reserves can by these suggested substitutes be entirely avoided. . This one vital distinction should be made : that in the case of operating reserves the debit is to an expense account, as Bad Debts, Depreciation, Taxes, or Royalties, and the entry re- duces the profits; while in the case of non-operating reserves, although the debit may be to Profit and Loss instead of to Sur- plus, the entry does not reduce the profits, but disposes of a part of the profits after their amount has been determined. 16. Surplus Impounding Not Necessarily Permanent Emphasis should be placed on the fact that the establishment of a reserve does not set aside any specific funds which cannot, even temporarily, be used for any purpose which may come up. The creation of the reserve merely appropriates for purposes set forth a certain amount of what might otherwise be declared as a dividend, and prevents for the time being the distribution of that much of the surplus, The setting aside and possible invest- 1052 CORPORATE ACCOUNTING [Bk. III- ment of specific funds for the same purpose is an altogether dif- ferent matter, the consideration of which, because such invest- ment occurs most frequently in connection with the redemption of bond issues and is necessarily treated in discussing them, is deferred to a later chapter. 3 It should always be remembered that the appropriation of Surplus does not in any way change its character. It is still sur- plus still a part of the excess of net assets over the capital stock and is an item in the net worth. 17. Analysis of Non-Operating Reserve Accounts The entries made to a reserve account which is an impound- ing of surplus will be of the following nature : Debit: With any deductions necessitated by loss or return of moneys credited. With transfers or appropriations from this reserve for the benefit of some other reserve, or back to the general surplus. With any amounts of money or other assets applied to the purpose for which the reserve was created, the corre- sponding credit being to surplus. Credit: With the amount appropriated out of profits at designated periods for the specific purpose for which the profits are reserved from distribution, the corresponding debit being made to Surplus or to Profit and Loss. With all income derived from the deposit or investment of money set aside in specific funds. With any profit on sales of securities belonging to a fund for which the reserve was established. Reserve accounts show credit balances. As the expenditures are made for which the reserve was created, the amounts of these expenditures should be debited to the reserve account and credited to Surplus. 4 18. Secret or Hidden Reserves The terms "hidden reserves," "hidden assets," and "secret reserves" are practically synonymous. These terms are famil- iar to accountants as representing the excess of actual net worth 3 See Ch. XXII, "Principles of Fund Accounting" See also Ch. XXIII, "Entry of Fund Transactions." Ch. 3] . RESERVE ACCOUNTS 1053 of a concern over and above the amount indicated on its balance sheet. Such reserves are not peculiar to corporations except as big business usually expresses itself through the corporate form. They are true reserves, because they represent net worth which, not appearing in the Surplus account, is not available for divi- dends, being impounded by methods not used for open im- pounding. Such secret reserves may be created either intentionally or unintentionally. For some reason, the directors may not wish to disclose in a financial statement the true status of the com- pany's condition, and they act accordingly in understating the true facts. This may be due to a spirit of conservatism which is permissible in case no one is injured thereby. Sometimes, how- ever, the actual net profits for a given year are understated for the purpose of lessening the state and federal corporation tax, and perhaps to keep both stockholders and competitors in ignor- ance of the company's actual earnings. Following are various acts or omissions which result in the creation of secret reserves : 1. Intentionally or inadvertently omitting assets which should be included. 2. Undervaluing assets, intentionally or otherwise. 3. Writing off too much depreciation. 4. Charging additions and improvements to Repairs or Maintenance account instead of to Plant account. 5. Creating reserves for bad debts in excess of the amount required. ' 6. Charging production costs, intentionally or otherwise, to expense instead of to the manufactured article, thus undervaluing the cost. 7. Including fictitious liabilities in the accounts, or over- stating actual liabilities. 8. Making additions or improvements and charging the cost to Surplus account, thereby hiding their value. 1054 CORPORATE ACCOUNTING . [Bk. III- 9. Neglecting to take into consideration in the accounts natural increases in value of real or other property. 10. Understating values in good years and increasing them in lean years as a means of keeping the dividends uniform from year to year. The secret reserve is sometimes considered a commendable creation in case it is not carried to excess and provided it is not detrimental to interested persons. The spirit of conservatism, to a reasonable extent, is to be commended by the accountant rather than criticized. If, however, stockholders are kept in ignorance of secret reserves of considerable amount, an injustice is done to anyone who may thus be induced to sell his stock for less than it is really worth. 19. Depletion and Exhaustion Reserves In the ordinary commercial undertaking the profits are made on the turnover, and at the end of a term of years the investment save in case of disaster is intact, and presumably the business is far more valuable than when it was started. In mining and similar undertakings, however, the profit is made from the re- moval of the mineral, and under ordinary conditions the value of the property becomes steadily less with each ton of ore removed, until on its final exhaustion there is left a tract of rough and worthless land and machinery of but little further value. In other words, the original investment has disappeared has been consumed, or realized upon, in the course of operation. This gradual working out or liquidation of. the original invest- ment is characteristic of mining, quarrying, timbering, and other operations, and, if the conditions are clearly recognized, is not in any way objectionable. Frequently, however, the owners prefer to establish a depletion reserve that will preserve the integrity of the original investment, so that profits only will be paid the own- ers from current operation. The establishment of such a depletion, exhaustion, or replace- ment reserve is a comparatively simple matter. The.amount of Ch. 3] RESERVE ACCOUNTS 1055 mineral in the mine, or of timber on the tract, is estimated; and a certain amount calculated to replace the original investment upon or before the exhaustion of the property, is reserved and set aside for each ton of ore mined, or for each thousand feet of lum- ber cut. The part of the original investment which is thus con- sumed as each ton of ore is removed and sold or as each thousand feet of lumber is cut and disposed of, is then charged to expense and credited to the Reserve or Allowance for Depletion. This is distinctly an operating reserve, being the amount of an expense incurred in making the profit, and is not an impounding of profits. Indeed, unless the cost of that part of the original investment consumed is charged against profits, these will be overstated. 20. Summary Under the most common modern corporate practice, assets are seldom specially set aside to represent true reserves or appro- priations of surplus (non-operating reserves), except in compul- sory cases, 5 the regular cash assets being relied on to meet any demands made for the purposes for which the reserves are estab- lished. But cash may be withdrawn from the business to provide an actual fund for any of these purposes, instead of simply re- serving profits from distribution. This cash, which is placed in a fund which is usually invested in securities easily realized upon, may be placed in the hands of a trustee, or of a committee of directors, or of the entire board. 6 'See i 216. See Ch. XXII, "Principles of Fund Accounting." CHAPTER IV CLASSIFICATION OF SURPLUS 21. Need of a Better Terminology The fact has long been recognized that the term "surplus" has too broad a meaning, in that as used it is simply a balancing figure between the net assets and the capital stock accounts. In fact it has many varying meanings and there is no uniformly accepted interpretation which can invariably be placed upon it. 1 It em- braces too wide a scope, from earnings to items of arbitrary ap- preciation, including the margin legally available for dividends along with entries which could by no stretch of the imagination be considered as proper for that purpose. Such a surplus may be diminished by writing down assets below their real value. When this is done the process is called "creating a secret reserve." When the credit side of the Surplus account is increased by fig- ures which do not represent realized profits, the act is called "creating fictitious assets," or "watering the assets/' When an asset account is arbitrarily increased by a book entry, the credit usually finds its way to Surplus. When a busi- ness wishes to falsify the amount of its surplus, it usually does so by inflating some fixed asset account. Consequently, a report of an auditor is of no value unless he analyzes all debits and credits to the Surplus account from the beginning of business, and is willing to certify, without qualification, to the correctness of the balance of the Surplus account at the time his audit is made. In certain businesses and industries the term surplus has de- veloped special meanings. In banks the surplus is almost as in- violable as the capital stock itself and is never used for dividends. The surplus of most banks is initially the premium on stock 1 Cf. {{ 6, 12. 1056 Ch. 4 l CLASSIFICATION OF SURPLUS 1057 sold, in addition to which each year they carry a given amount of the net profit to Surplus account to serve as permanent work- ing capital, while the remainder after payment of dividends is carried in the Undivided Profits account. Such special uses of the term surplus have become in many cases so well established that no change in the interest of general uniformity may be expected. As a result surplus means one thing to one man, while to another it may mean an entirely dif- ferent thing. But the confusion exists and as it cannot readily be dissipated it must be faced and surmounted. The best way of doing this is by dividing the functions of the Surplus account 2 among several accounts, each of which will have a title suffi- ciently distinctive to show the source of its balance. ' 22. Earned Surplus The most common form of surplus is earned surplus, and the word "surplus" probably carries with it the connotation of "earned surplus" more often than any other. The uses of an Earned Surplus account, when the Surplus account is divided on the books into its component parts, are as follows: EARNED SURPLUS Credit: With any adjustment during a fiscal period which increases the profits of a previous fiscal period. At the close of each fiscal period, \vith the net profit, if any, as shown by the Profit and Loss account. Debit: With any adjustment during a fiscal period which diminishes the profits of a previous fiscal period. At the close of each fiscal period, with the net loss, if any, as shown by the Profit and Loss account. With any dividends declared or paid, or any amount appropriated, out of earned surplus. Several different methods of handling profits on the books are in use. Some of these introduce an account known as "Undivided Profits," a name which itself has three uses. In one usage Un- 1 See Ch. II. "The Surplus Account.". . 1058 CORPORATE ACCOUNTING [Bk. Ill- divided Profits account has the same meaning as that assigned above to Earned Surplus. In another usage it is the account in which earnings are first entered and from which certain amounts are occasionally -transferred into a permanent surplus account. This method merely subdivides the earned surplus into two ac- counts more or less arbitrarily. The third use of the account as distinguished from Earned Surplus, is as a place in which to carry the unappropriated profits of the last closing, the undivided profits of other periods being transferred to the Surplus account. 23. Capital Surplus The term "capital surplus" has a rather wide range of mean- ings, including all accretions to capital other than ordinary earn- ings. Within this scope will be the functions assigned below to Paid-in Surplus, Surplus from Appreciation, and Donated Sur- plus. The term is used sometimes to include also unusual and extraneous profits and losses, especially those resulting from the sale of capital assets. 24. Paid-in or Contributed Surplus Debit: With the discount on the sale of the corporation's capital stock. With any dividends declared or paid, or any amounts impounded out of Paid-in or Contributed Surplus. Credit: With the premium received on the sale of the corporation's capital stock. With payments made on stock subscriptions, if forfeited on account of failure to complete contract. With the amounts of assessments on stock. With the difference between the par value of reductions of capital stock outstanding and the price paid to the holders, if less than par. With the amount by which the value of tangible assets received for stock unquestionably exceeds the par value of the stock issued therefor. With the profit on sales of treasury stock which has been repurchased for value. Ch. 4] CLASSIFICATION OF SURPLUS 1059 25. Sources of Paid-in Surplus Sometimes stock is subscribed for at a figure above its par value, and a surplus is thus created by contribution at the time the company is organized. This is done in order that the com- pany may have a safety fund for emergencies, or additional work- ing capital while the business is being launched. In that case Paid-in Surplus or Contributed Surplus account is usually credited with the amount of the premium on the capital stock. This plan is commonly employed in the organization of national banks in which the stockholders are liable for debts of the com- pany to an amount equal to the stock they hold. The practice is to sell the stock at, say, $125, $150, or even $200 per share, in which case the double liability of the stockholders is completely provided for and the institution itself secures a material addition to its working capital. While dividends may be declared out of paid-in surplus -as out of earned surplus, yet payments by banks out of premiums received on capital stock, if they have the effect of reducing that premium below the amount for which stockholders are liable to creditors, would counteract the freedom from liability secured by the original premium. Paid-in surplus results also from the reduction of the par value of capital stock outstanding without full recompense to the stockholders. This circumstance frequently occurs in reor- ganizations, when fewer shares of the new stock are given than were held of the old. ' The original stock was paid for with cash or other assets ; wherefore, if less stock is now issued, the excess becomes a premium on the purchase of the new. Assessments on stock, when lawful or when accepted, also create a paid-in surplus. Such assessments are usually made pro rata on the outstanding shares in cases of reorganization or im- pending bankruptcy. They are generally used either for wiping out a deficit from operating losses, or else, as in the case of fra- ternal insurance organizations, for providing for expenses and losses as they arise. io6o CORPORATE ACCOUNTING [Bk. III- If stock is sold in exchange for tangible assets which have a value unquestionably greater than the par value of the stock issued for them, there is created a paid-in surplus. The valua- tion of intangibles is, however, so much a matter of opinion that it would be difficult to say that any such assets purchased for stock had a value unquestionably greater than the par value of the stock issued therefor. For this reason it is improbable that the accountant is ever justified in allowing a paid-in surplus to be created on account of intangibles. A paid-in surplus also results from the making of initial pay- ments on subscriptions for capital stock and their subsequent forfeiture. If a corporation sells at a profit its own stock which it has re- purchased from holders for value, a paid-in surplus is thereby created. 26. Surplus from Appreciation When it is felt necessary to increase the book figures for capi- tal assets whose market value has increased since they were ac- quired, the credit should never be merged with real gains legally available for dividends, but should be entered to an account called "Surplus from Appreciation" or "Appreciated Surplus." This is true even if all other forms of surplus are handled through one general Surplus account. The practice of entering apprecia- tion on the books is widely condemned because of improper in- flations which may be hidden behind it. if, however, a surplus so created is displayed on the balance sheet in such a way as to be definitely separated from surplus arising from other sources, no one need be deceived by it. A surplus created by appreciating the book values of capital assets should be reduced through the remainder of the life of the asset. This very important point should not be overlooked. The depreciation on assets carried on the books at an appre- ciated value should be divided into two parts, as not all of it is a charge against income. The portion of the depreciation which Ch. 4] CLASSIFICATION OF SURPLUS 1061 applies against the cost of the asset is properly a debit to income, but the part which applies against the appreciation must be charged against Surplus from Appreciation, and not as an oper- ating expense. For example, a factory is erected on a certain piece of prop- erty at a cost of $100,000. If the life of the building is estimated at 50 years, an annual amount of $2,000 will have to be charged against income for the depreciation of the building (using straight-line methods). If at the end of 10 years the building is appraised at $200,000 and it is thought necessary to put the ap- praisal figure on the books, the entry required will be: Buildings $i 20,000 To Surplus from Appreciation $120,000 To record increase in value of building from its present book value of $100,000 Less: Reserve for Depreciation of 20,000 Net book value $ 80,000 To the appraised value of 200,000 An appreciation by appraisal of ........... $120,000 The remaining life of the building is 40 years, over which the present book value of $200,000 must be charged off, making an annual reduction by straight-line methods of $5,000. But since an annual charge of $2,000 will be sufficient to extinguish the cost of the asset at the expiration of its period of usefulness, the remaining $3 ,000 must be charged against the amount of appre- ciation. The annual entry will be: Depreciation .............. , ..................... ..... .... $2,000 Surplus from Appreciation ........... ............. 'Ji.J.n/j W'. . 3,000 To Reserve for Depreciation ...................... ,13. giji $5,000 (With the proper explanation.) A proof of the accuracy of this method is shown by the fol- lowing figures. The $120,000 of Surplus from Appreciation pre- viously set up is charged off at the rate of $3,000 for 40 years, clearing the original appreciation during the life of the building. The cost of $100,000 is charged off at the rate of $2,000 a year 1062 CORPORATE ACCOUNTING [Bk. III- for 50 years. The amount charged to Buildings account, namely, $100,000 of cost and $120,000 of appreciation, is offset at the end of 50 years by a Reserve for Depreciation made up of: $2,000 per year for 10 years $ 20,000 $5,000 per year for 40 years 200,000 Total $220,000 Only the $2,000 depreciation of the actual cost of the build- ing is a charge against income. The uses of the Surplus from Appreciation account may then be summarized as follows: SURPLUS FROM APPRECIATION Debit: With the depreciation taken pe- riodically on appreciation previously entered. Credit: With the amounts by which the book value of fixed assets is increased. 27. Objection to Appreciation of Book Values The objection to entering appreciation on the books is not due to anything necessarily inherently wrong in that procedure, but results from the confusion which follows the attempt to overdo such recording of fluctuations of value, and from the mis- fortunes which have resulted from making it appear as though a dividend were possible in excess of the truth. It is possible, per- haps, to see an argument for entering increases of value which are permanent and reasonably definite in amount, as a credit to Surplus ; but the entry of such increases for the purpose of creat- ing a fictitious surplus on which to declare dividends, should be severely condemned by accountants and corporation officials. It is not good business prudence to use appreciation of values for dividend purposes. Dividends declared and paid on the strength of fictitious profits must as a rule be accounted for in case of the company's failure; it is equivalent to paying dividends out of capital, an impairment for which directors are personally liable. Ch. 4] CLASSIFICATION OF SURPLUS 1063 28. Donated Surplus Another source of surplus arises from donations to the cor- poration of part of its own capital stock by the stockholders. The purpose of such donations is to provide working capital, usually in cases where the entire or a large percentage of the cor- poration's capital stock has been originally issued in exchange for fixed or intangible assets, leaving no means of securing funds for making those assets yield an income. It may, however, usually be assumed that the donation of capital stock immediately after its issue is prima facie an indica- tion that the assets for which the stock was issued were turned in at a value so inflated that those who turned them in are more than recompensed by the amount of stock which they have with- held. The assets being thus carried at an inflated value, there is no real surplus existing in the donation. This kind of a surplus involves a number of accounting prob- lems which are fully discussed in a later chapter. 3 There is another form of donated surplus against which there is no such prejudice as exists against a surplus created by the immediate return of stock to a corporation. This arises from donations from outsiders of factory sites and other bonuses such as are sometimes given to induce business enterprises to locate in certain places. The entry of the values of these donations on the books when the conditions of the gift have been fully complied with and it can no longer be forfeited, is not improper. Such en- tries involve debits to various asset accounts and a credit to Donated Surplus. . 29. Consolidated Surplus There is another kind of surplus which, while related to Sur- plus from Appreciation, is of unquestioned propriety because in it is found almost the only way of handling the adjustments found necessary in the preparation of consolidated balance sheets. Ch. X, "Par-Value Donated Stock." 1064 CORPORATE ACCOUNTING [Bk. III- When one company owns the stock of another and it is desired to present a consolidated balance sheet showing the total assets represented by the stock of the first company together with its existing liabilities, it is necessary to substitute for the cost of the stock of the subsidiary company the entire list of the assets of that company together with its liabilities. It is seldom that the net worth of the second or subsidiary company, as- shown by its books, will be exactly equal to the cost of its stock to the holding company, and in the preparation of the consolidated balance sheet the difference must be taken up through a consolidated surplus (or a consolidated deficit, if the book net worth of the subsidiary were less than the cost of its stock to the holding com- pany) . The causes of the conditions which make this necessary, together with the accounting, are fully discussed in later chapters. 4 See Chs. XXXIV and XXXV. "Consolidated Statements." Part II The Original Capital of the Corporation CHAPTER V PAR-VALUE STOCK OF ORIGINAL ISSUE FULL-PAID AT ONCE 30. General Conditions The opening entries on the books of a corporation are deter- mined by the conditions under which the stock is sold, and it is important that such entries should be complete and clear. They sometimes fail in this and are obscure because of insufficient data in the journal entries. This may be due to carelessness or ignorance, or occasionally to the desire of thfe incorporators to withhold certain facts regarding the company's organization that might be used later to their disadvantage. As to this, it can only be said that all entries should tell the truth clearly and unmistakably; and it may be added that, no matter how cun- ningly such entries are devised, a competent accountant can always discover their true meaning. Entries covering the various conditions of stock issues as given in the present and the succeeding chapters, include the following: 1. Entries for original issues of stock sold under different conditions. 2. Entries relating to stock donated to the treasury. 3. Entries where an original issue of stock or treasury stock is given in direct payment of corporate obliga- tions. 1065 1066 CORPORATE ACCOUNTING [Bk. III- 4. Entries relating to the purchase and sale by the corpora- tion of its own stock (not an original issue), and of other stocks. The entries given are intended merely to show the debits and credits directly resulting from the transactions considered. In practice all cash entries are of course recorded in the cash book and are thence posted to the proper ledger accounts ; but through- out the present volume, for the sake of clearness, the entire transaction is in each case expressed in the form of a journal entry regardless of whether it belongs in the cash book or journal or should be divided between the two books. 31. Capital Stock With and Without Par Value The recording of transactions in a corporation's own stock differs, when the stock has a specified par value from that re- quired when the stock is of no par value. This and the chapters immediately following deal entirely with stock which has a specified par value. The much simpler accounting of stock without par value is discussed in a later chapters 32. Formal Statement upon Opening Books Some authorities advocate opening the books of a corpora- tion with a short statement of the facts of organization and original issue, such as the following: The Davison Mercantile Company has this day been organized with a capital stock of $^ "o ^oo, divided into 1,500 shares of a par value of $100 each, all of which were subscribed for at par, as follows: A. W. Davison 800 shares George H. Brandon 300 " R. S. Cooke 200 " James Robinson 200 " All subscriptions have been paid in cash, excepting that of Davison, who turned over merchandise on his subscription to the i Ch. XI, "Capital Stock Without Par Value." Ch. 5] PAR- VALUE STOCK OF ORIGINAL ISSUE 1067 value of $50,000 and paid the balance, $30,000, in cash. The total amount paid in is therefore $150,000, of which $100,000 is cash. Such an entry should be a reasonably complete statement of the conditions under which the corporation is organized, and is desirable in order to bring together into one clear, concise state- ment all the details of the incorporation required by the accoun- tant. This relieves the opening entries of this data. The full facts regarding the organization so far as they affect the ac- counting should appear on the books; if the formal statement is not used, the explanation of the initial journal entries must be the more extended. 33. Initial Issue of Stock, Full-Paid The following entries are required to record the issuance of stock to the incorporators of the Davison Mercantile Company for the cash and merchandise turned over: Cash Book: Cash $100,000 To Capital Stock $100,000 Cash received by the company in full payment of sub- scriptions to its capital stock, as follows: A. W. Davison 300 shares George H. Brandon 300 " R. S. Cooke 200 " James Robinson 200 " Journal: Merchandise $50,000 To Capital Stock $50,000 Merchandise to amount of $50,000 turned in by A. W. Davison as part payment of his subscription, the balance being paid in cash. Such entries as these on the books of a new corporation should contain a reasonably complete statement of the conditions under which the corporation is organized, at least as full as that given above, unless a formal opening statement 2 is used. 'See 32. io68 CORI'OKATK ACCOUNTING [Bk. III- The above entries are the simplest possible. Incoming cash and merchandise receive their proper debits, and Capital Stock account is credited with the amounts subscribed, paid for, and issued. The function of Capital Stock account is as follows: CAPITAL STOCK Debit: With the par value of any reduction in the amount of the stock authorized to be issued. Credit: With the par value of shares au- thorized for issue. This account shows a credit balance, indicating the par value of stock authorized for issue, and is frequently known as Capital Stock Authorized account. 34. Unissued Stock In the above example the entire amount of stock authorized was immediately issued. But let us suppose that the Davison Mercantile Company had been authorized to issue 2,000 shares instead of 1,500, all the other conditions as to par value and amount subscribed remaining the same. In this case it would be desirable to show the entire amount of the authorization by an opening entry in the following form before recording the issuance of any of the stock: Capital Stock Unissued $200,000 " To Capital Stock (or Capital Stock Authorized) $200,000 The Davison Mercantile Company has been organized with an authorized capital stock of $200,000, divided into 2,000 shares of a par value of $100 each. The function of the Capital Stock Unissued account is: CAPITAL STOCK UNISSUED Debit: With the par value of shares au- thorized, the offsetting credit being made to Capital Stock Authorized. Credit: With the par value of shares issued, the offsetting debit being made to Cash, to the proper property account, or to Capital Stock Subscribed, as the case may be. Ch. 5] PAR-VALUE STOCK OF ORIGINAL ISSUE 1069 The debit balance of this account shows at all times the par value of the stock authorized by the corporate charter but not yet issued. The account is a negative to Capital Stock Au- thorized account. The par value of the stock issued at any date is the difference between the ledger balances of the Capital Stock Authorized and Capital Stock Unissued accounts. When this plan of first setting up the authorization is fol- lowed, all entries for the issuance of stock will be credits to the Capital Stock Unissued account instead of to the Capital Stock or Capital Stock Authorized account. In the case of the Davison Mercantile Company, the cash book and journal entries recording the receipt of the cash and merchandise for the stock would be exactly as given above, with the single ex- ception that in each case the credit is to Capital Stock Unissued. 35. Preferred Stock The accounts above presented, Capital Stock Authorized and Capital Stock Unissued, are used as shown when but one class of stock is authorized. If there is more than one kind of stock it will be necessary to use these same accounts with distinctive titles for each kind of stock, as Common Stock Authorized, First Preferred Stock Authorized, Second Preferred Stock Au- thorized, Common Stock Unissued, First Preferred Stock Unis- sued, Second Preferred Stock Unissued, etc. These accounts are handled just as are the Capital Stock Authorized and Capital Stock Unissued accounts, each account of course con- taining entries affecting only its particular class of stock. The same rule will apply to the capital stock accounts sub- sequently discussed, such as Capital Stock Subscribed, etc. 36. Another Use of the Capital Stock Account Many corporations, instead of showing on the books the amount of capital stock authorized when not all of it has been issued, have followed the practice of simply crediting Capital Stock account with the par value of the issued stock. When 1070 CORPORATE ACCOUNTING [Bk. III- this is done the balance of the Capital Stock account represents the par value of the stock issued and outstanding, and the amount of the original authorization does not appear, whereas the use of accounts for Capital Stock Authorized and Capital Stock Unissued affords a means of recording a neutral opening entry in the corporate books, showing the amount of the original authorization. In the case of the Davison Manufacturing Company, the entries for the stock issued would be the same as those suggested first above, 3 Capital Stock being credited. The opening entry setting up the amount of capital stock authorized would, how- ever, be entirely omitted. The use of this single account is going out of favor, the present tendency and the better practice being to require the books to show the amount of the authorized stock. The amount issued is determined by subtraction of the balance unissued (as shown by the Capital Stock Unissued account) from the amount authorized (as shown by the Capital Stock or Capital Stock Authorized account). Of course, if there is no unissued stock, the balance of the Capital Stock account will be both the amount authorized and the amount issued. 37. Summary of the Capital Stock Accounts The capital stock accounts as above constituted show the amount of capital invested in the corporation by the stock- holders (who are the real owners), very much as the capital account of a partnership or sole proprietorship business shows the investment of the partners or proprietor. The accounts do not represent any strict liability to the stockholders, whose claims in the event of liquidation are considered only after all secured and unsecured creditors are satisfied. If the single Capital Stock account is used, its balance will represent the par value of the stock issued and outstanding. If the authorized and unissued accounts are opened, the balance 'See i 33- Ch. 5] PAR-VALUE STOCK OF ORIGINAL ISSUE 1071 of the Capital Stock Authorized account shows the total author- ized stock, while the balance of the Capital Stock Unissued account shows the amount still unissued, the difference being the par value of the stock outstanding. 38. Subsidiary Stock Records 4 The amount of outstanding stock is shown in shares by the stock certificate book. The stock ledger will also show the stock issued and outstanding, though ordinarily in shares and not in value. These books will constitute a subsidiary record, the Capital Stock account becoming the controlling account if only that account is used. If the Capital Stock Authorized and Capital Stock Unissued accounts are used, the control is the amount of the difference between their balances. WhoJr' !<(;>': 39. Stock Ledger Some form of stock book, stock ledger, or share ledger which are practically one and the same must, in most states, be kept as a matter of statutory requirement. The stock ledger is intended primarily to show the stock acquired, any transferred, and the number of shares held at the time by each stockholder; but it is sometimes used also as a ledger to show payments made on account of subscriptions. This record is better kept in a separate subscription ledger. It is obvious that the great majority of the stock ledger entries are transfers of stock in which the . corporation has no financial interest; and the financial side of the comparatively few original entries in which it is interested should not be brought into this book. The stock ledger is the proper legal evidence of the owner- ship of stock in a corporation. It records the name and address of each stockholder, the number of shares issued to him, any shares subsequently acquired, any shares transferred, and the balance of shares remaining to his credit. It also shows the See Book I, Ch. XXXVII, "The Stock Records"; also Book IV, Ch. VI, "Stock Certi- ficates," and Ch. VII, "Stock Books." 1072 CORPORATE ACCOUNTING [Bk. III- numbers of the certificates issued to the individual, the numbers transferred, and the date of each transaction. Postings to the stock ledger are made from the stock certificate books, except that transfers of stock may be posted from the transfer book, transfer register, or stock certificate books. 5 Preferred stock should be recorded in a separate stock book, or in its own section of the stock ledger; for it is obvious that the attempt to keep a record of both kinds of stock in one account would lead to confusion. A Capital Stock account is sometimes opened on the front page of the stock ledger, and debited with the aggregate amount of shares credited to the stockholders' accounts. This provides a double entry for the stock ledger, and enables the secretary to tell at any time the amount of stock outstanding. The stock ledger must, of course, agree as to totals with the Capital Stock account in the general ledger, or with the Capital Stock Au- thorized account less the shares represented by the Capital Stock Unissued account, depending on which method is followed. 40. Form of Stock Ledger It must always be kept in mind that the great object of the stock ledger is to show at any time the number of shares then standing in each stockholder's name not the amounts paid on these shares, nor their par value, but the number of shares. In practice there are two methods of keeping this record. In some forms the stockholders' accounts are debited for stock pur- chased, and credited for stock sold; while in others the stock- holders' accounts are credited when stock is purchased, and debited when it is sold. This variation is not a matter of importance so long as the details are correctly recorded and full information is obtainable, but inasmuch as the stock ledger is subsidiary to certain accounts in the general ledger, the usual practice in regard to subsidiary ledgers should be followed. This rule would indicate that, since the entry of the issuance of See t 43- Ch. 5] PAR-VALUE STOCK OF ORIGINAL ISSUE 1073 the stock is a credit on the general ledger, the stock should be a credit to the individuals on the stock ledger; that, since the balance of the controlling account is a credit, the items which make it up should be credits. The stock accounts of the indi- viduals are credit accounts just as are proprietorship accounts or partners' capital accounts. 41. Reconciliation of Subsidiary Stock Records Many corporations have treated the stock ledger and certifi- cate books as if they were not a part of the general accounting system. The sooner the fact is fully recognized that these records are subsidiary to certain accounts on the general ledger, the less difficulty there will be in keeping both records accurate. Many of the corporations which have sprung up in such numbers during the last few years and opened their subscription lists to the public, using many salesmen to sell their shares over a wide territory, have had to spend large amounts on audits, the greater part of which expense has been due to the cost of recon- ciling records which should have been kept in as close accord as the customers ledger and its controlling Accounts Receivable, or the purchase ledger and its controlling Accounts Payable. In corporations of this type especially, should the stock ledger be balanced with the certificate books monthly, and the amount of outstanding stock be reconciled with the general ledger. If any adjustments are needed, they should be made at once. When a corporation has issued no new stock of original issue during the month, the reconciliation of the former m6nth may of course be used. When all the authorized stock has been issued the problem of reconciliation no longer exists. But just as the Accounts Receivable control is represented by a schedule of amounts due from customers, which is a trial balance of the cus- tomers ledger, so should the Capital Stock control (or the differ- ence between the balances of the Capital Stock Authorized and Capital Stock Unissued accounts) be represented by a schedule 1074 CORPORATE ACCOUNTING [Bk. III- of outstanding stock of the same par value, which is nothing more than a trial balance of the stock ledger and certificate books. 42. Transfers of Stock The transfer of stock has been very fully discussed. 6 Because of its bearing on the ease of keeping the accounting records accurately, one point must be repeated here. When the holder of a certificate for a number of shares desires to transfer part of them, his certificate is canceled, a new one is issued in favor of the transferee for the number of shares transferred, and a new one is also made out in favor of the transferrer for the number of shares retained. The lack of knowledge or lack of care through which secretaries of corporations have issued certificates for transferred portions or the whole amount of outstanding cer- tificates without requiring the surrender of the old ones for can- cellation, has led to much trouble. Sometimes a stockholder desires to surrender a certificate and take in exchange two or more certificates, each for a smaller number of shares. This is called a "split." Or sometimes several certificates of smaller amounts are surrendered in ex- change for a single certificate. This also is known as a "split." In any of these cases, the certificates must be assigned as required by the conditions, and the proper records must be made In the transfer book, in the transfer register, and in the stock certificate book (or such of these books as are used), the can- celed certificates being pasted back on their own stubs at the time the new issue is made. 43. Register of Transfers 7 A transfer register or transfer journal is sometimes used. This book serves as a convenient medium through which postings are made to the stock ledger. It is apparent, of course, that for See Book I, Part VIII, "Stock Records and Stock Transfers." ' See Book IV. Form 256. Ch. 5] PAR-VALUE STOCK OF ORIGINAL ISSUE 1075 every stock certificate transferred, a debit must be made to the transferrer and a credit to the transferee. A transfer register is required only in large corporations where many transfers are being made. In a small company where the stock is inactive, it is not necessary; and postings may then be made from the transfer book or even from the stock certificate book. Transfers of stock require no entry on any books except those having to do solely with transfers and the stock ledger. CHAPTER VI PAR-VALUE STOCK OF ORIGINAL ISSUE NOT FULL-PAID AT ONCE 44. Setting Up Subscription Assets Sometimes subscriptions to stock especially when on the instalment plan fail after they are made. Stock certificates should not be issued to subscribers until their respective sub- scriptions have been paid in full. In the interim their subscrip- tions are in the nature of accounts receivable, although these are assets which do not rank so highly as do amounts due from customers. To set such assets up on the books and to show the amount of stock reserved to fill these subscriptions, the opening entries shown below are necessary. The Davison Mercantile Company, whose stock was in the preceding chapter considered as full-paid, is again taken as an illustration, but now with the assumption that Robinson did not pay for his stock immediately. Capital Stock Unissued $200,000 To Capital Stock Authorized $200,000 (Explanation as in 33.) Subscriptions to Stock $150,000 To Capital Stock Subscribed $150,000 1,500 shares subscribed for at par by the incorporators: A. W. Davison 800 shares George H. Brandon 300 " R. S. Cooke 200 " James Robinson 200 " Cash $80,000 To Subscriptions to Stock $80,000 Payments of incorporators' subscriptions to stock: A. W. Davison $30,000 George H. Brandon 30,000 R. S. Cooke 20,000 1076 Ch.6] PAR- VALUE STOCK OF ORIGINAL ISSUE 1677 Merchandise $50,000 To Subscriptions to Stock $50,000 Payment of balance of Davison's subscription to stock, paid in merchandise as per agreement. Capital Stock Subscribed .'."^.'i '". : $150,000 To Capital Stock Unissued ' $150,000 Certificates Nos. i, 2, and 3 issued to those of the in- corporators who have paid the amounts of their sub- scriptions. 45. Subscriptions to Stock l Debit: With the amount of subscriptions for capital stock. (At this time credit Capital Stock Subscribed.) Credit: With all moneys or property received to cover subscriptions; or with the amount of each instalment due by subscribers when an Instalment account is maintained. With the unpaid balances of sub- scriptions canceled. Other names for this account are "Subscription," "Stock Sub- scriptions," and "Subscribers." It is debited with the full amount of the subscriptions, and credited with the payments made. When the account balances, it shows except when an Instalment account is used that all stock subscribed has been paid for. Any balance in the account is an asset, and again save when an Instalment account is opened represents the amount due and unpaid on subscriptions for capital stock. The account is opened to show the total amount of subscriptions, even though payment of part or all of these is to be made in full at once or in a short time. Subscriptions to treasury stock should preferably be opened under another heading, such as "Subscrip- tions to Treasury Stock," to distinguish them from subscriptions to unissued stock. A subscription ledger should be kept as a subsidiary record to Subscriptions to Stock account, as explained later in the chapter. 1 Separate account for each class of stock sold. 1078 CORPORATE ACCOUNTING 46. Capital Stock Subscribed 2 [Bk. III- 'Credit: With the par value of capital stock subscribed, debiting Subscriptions Stock account. to Debit: With the par value of stock sub- scribed for and credited to this account. (Entry to be made when certificates of stock are issued covering the number of shares subscribed and paid for, crediting Capital Stock Unissued.) With the par value of any canceled stock subscriptions which have been credited to this account. 3 Capital Stock Subscribed account is opened as a suspense ac- count in which the amount of stock reserved on account of sub- scriptions received and entered may be carried until the certifi- cates are issued, which it is ordinarily assumed will not be until they have been paid for in full. It is the actual issuance of the certificates which controls the debits to this account rather than the payments. The Capital Stock Unissued account is not affected until the certificates are actually issued. In this con- nection it should' always be remembered that the issuance of certificates for unpaid or partly paid subscriptions is to be condemned. 4 The Capital Stock Subscribed account shows, not the amount due on subscriptions, which is shown by Subscriptions to Stock account, but the total original par value of all subscriptions the certificates for which have not been issued. When subscriptions are paid in full and certificates are issued, the Capital Stock Sub- scribed account is debited and Capital Stock Unissued account is credited. If sales are made at par and no certificates are issued until full payment is received, the difference between the balance of Subscriptions to Stock account and the balance of this account should show the amount of cash received on account of subscriptions for which certificates have not been issued. Assume that A, B, and C have subscribed for stock in the re- 2 Separate account for each class of stock subscribed. See S 48. See Book I, 259. Ch. 6] PAR-VALUE STOCK OF ORIGINAL ISSUE 1079 spective amounts of $100, $500, and $1,000, and that A has paid all of his subscription, B has paid $200, and C nothing. C is to get his stock for $800. None of the certificates have been issued. The entry setting up the subscriptions would be: Discount on Stock $ 200 Subscriptions to Stock l> ^llnpgCWa. ?. . 1,400 To Capital Stock Subscribed $1,600 (With full explanation.) The receipt of the money would be recorded by entries which aggregate : , >vlo^yi vbh;-. J'.c>ift.iiti '/lir.uzu Cash $300 To Subscriptions to Stock $300 It was said above that the Capital Stock Subscribed account represented the total original par value of all subscriptions the certificates for which have not yet been issued. The application of this principle to the simple case given will be apparent. In reconciling more complicated cases it is of value to remem- ber that the balance of the Capital Stock Subscribed account at any time represents the sum of the par value of any stock sub- scribed for and now fully paid but not yet issued, plus the balance in the Subscriptions to Stock account, plus the cash received on account of the outstanding subscriptions, plus any discount or minus any premium at which the stock not yet fully paid for was sold. Applying this rule to the case just given we have: Par value of the stock subscribed for and now fully paid but not yet issued (A's subscription and payment) $ 100 Balance in the Subscriptions to Stock account ($1,400 minus $300) r,ioo Cash received on account of the outstanding subscriptions (from B) 200 Discount at which the stock not yet fully paid for was sold (on C's sub- scription) . . . 200 Balance in the Capital Stock Subscribed account oU/lt J. $1,600 When A's stock is issued the following entry will be made : Capital Stock Subscribed $100 , ~ .. , c . , TT . , e To Capital Stock Unissued $100 (With full explanation.) loSo CORPORATE ACCOUNTING [Bk. III- The balance in the Capital Stock Subscribed account will then be $1,500, which will be represented by all the items in the above schedule except the first, there being then no stock sub- scribed and fully paid for but not issued. Instead of opening the Capital Stock Subscribed account, credits for stock subscribed on the instalment plan are frequently but not wisely made directly to Capital Stock. The question of when it is worth while to open accounts with Subscriptions to Stock and Capital Stock Subscribed is for the accountant to de- termine, but any doubt as to the advisability of using them will usually be most safely resolved by an affirmative answer. 47. The Subscription Ledger Subscriptions to Stock account is debited with the full amount of each subscription. As these are paid the account is credited. When there is an unpaid balance in the account the items making up that balance will be found by taking a trial balance of the sub- scription ledger, which should be kept as a record subsidiary to the Subscriptions to Stock account. An account with each sub- scriber will be kept therein. The respective subscribers' accounts should be debited separately with the amounts of their subscrip- tions, and credited with the amounts of the payments which they make on account of the subscriptions. The result of a trial bal- ance taken from this subsidiary ledger should, as suggested above, agree with the balance of the Subscriptions to Stock account, and such a comparison should be made monthly as long as the Subscriptions account is active. Any form of small ledger sheet, card, or bound book is suit- able for a subscription ledger, as the debits usually show only date, subscription number, number of shares subscribed for, journal folio from which posted, and amount; and the credits show only date, receipt number, cash book folio from which posted, and the amount. Subscribers' accounts are sometimes opened in the general ledger; but in practice it is better to open the individual accounts Ch. 6] PAR-VALUE STOCK OF ORIGINAL ISSUE 1081 in a subsidiary ledger as above suggested, letting Subscriptions to Stock account in the general ledger represent all these as a controlling account. 48. Cancellations of Subscriptions Cancellations of subscriptions are frequently permitted by corporations in the interests of business policy. If no payment has been received the cancelling entry will be simply: .hsnnsifl -A :4n. Capital Stock Subscribed $5,000 To Subscriptions to Stock $5,000 Recording cancellation of subscription No. 108 of Charles J. Davis, for 50 shares. If money has been received which it is decided to refund, the transaction will be entered in the journal as follows for the amount unpaid: Capital Stock Subscribed $4,700 To Subscriptions to Stock $4,700 Recording cancellation of unpaid balance of subscription No. 108 of Charles J. Davis, for 50 shares. The following entry will be made in the cash book for the amount paid and now refunded: Capital Stock Subscribed $300 To Cash $300 Charles J. Davis, refund of payment on subscription. If some or all of the money paid is to be retained by the cor- poration, the same journal entry will be made. If in this case the company refunds in cash $200 of the $300 paid, the book entry will be: Capital Stock Subscribed ' $300 To Cash .j <)0 > -; $200 Premium 100 Charles J. Davis, refund of $200 of payment on canceled subscrip- tion, balance being retained. Io8a CORPORATE ACCOUNTING [Bk. Ill- The Premium account is credited with the amount of cash forfeited when stock subscriptions are canceled. Other uses of the account are presented in a later chapter.* 49. Sales of Stock After Organization Later sales of stock by a company will be entered just as were the sales at the time of incorporation. Assuming that on Janu- ary 3, 1922, $100,000 of the unissued stock of the Lancaster Cement Company has been sold at par to Frank K. Brennan, one-half for cash and one-half in 30 days, the following entries would be required: January 3, 1922 Subscriptions to Stock $100,000 To Capital Stock Subscribed $100,000 The Lancaster Cement Company has this day sold to Frank K. Brennan $100,000 of its unissued stock, one- half payable in cash and the balance in 30 days. Cash $50,000 To Subscriptions to Stock $50,000 First payment of 50% on Brennan's stock subscription. February 2, 1922 Cash $50,000 To Subscriptions to Stock $50,000 Final payment of 50% on Brennan's subscription to $100,000 of stock. Capital Stock Subscribed $100,000 To Capital Stock Unissued $100,000 Certificates Nos. 725-744 for 1,000 shares, issued to Frank K. Brennan upon full payment of his sub- scription. 50. Transfers of Subscriptions Transfers of subscriptions, whether entirely unpaid, or partly or fully paid, are sometimes permitted. If these are proving in any particular case to be numerous, it is sometimes wise to pro- vide a subscription transfer journal along the lines of the stock 6 See i 66. Ch. 6J PAR-VALUE STOCK OF ORIGINAL ISSUE 1083 transfer journal or register;* or the "Unpaid" column of that form may be used for recording transfers of subscriptions. If the latter practice is followed, the full number of shares unissued on the transferred subscription should be shown in this column. The subscription transfer journal is provided with columns headed "Shares" and "Unpaid Balance," instead of those en- titled "Paid In" and "Unpaid" on the stock transfer register. In any case the amount of the unpaid balance is credited to the transferrer on the* subscription ledger, and debited to the transferee. It is well to show the entire transaction on the new account opened for the transferee. The entries might be made as follows: Transferred s Account: H. W. JARVIS 1922 1922 June UA4*, 16 zoo shares. . . .116 $10,000 June 16 Cash C; $1,000 July 14 Cash. .Ci9 1,000 bou> f'i rmd lav Jon sari Jifd 10) j Aug. 2 Transfer to >rij i)\tt LwiiQOi) See Book IV, Form 254. Ch. 7] STOCK SUBSCRIPTION SYSTEM 1087 From the cash book, which is provided with a column, Receipts from Subscriptions, the monthly total is posted to the general ledger. From the cash book these payments must be posted in detail to the subscription ledger, in which the date, cash book folio, and amount are shown in the proper columns. In this way the Subscriptions to Stock account on the general ledger, which had previously been debited in totals with the amount of subscriptions, is now credited in totals with the payments and must necessarily show as a resulting debit balance the amount still due. In the same way, the total of the indi- vidual subscriptions entered on the detailed subscription ledger less the payments which have been recorded thereon, will be the amount of subscriptions still unpaid, shown in detail for each subscriber, the total of all the detail balances agreeing with the "control," i.e., the Subscriptions to Stock account, in the general ledger. 55. Issuance and Transfer of Certificates* Whenever a certificate is given representing stock previously unissued, i.e., an original issue, the number of shares and cer- tificate number are entered from the certificate stub to the stock ledger. The total number of shares represented by all certifi- cates issued and outstanding is added on the certificate stubs, and the following journal entry is made monthly : Capital Stock Subscribed To Capital Stock Unissued uX 21 When stock is transferred from one owner to another, the transfer is entered in the transfer register, 3 no entry being made in the general journal. All transfers must be posted from the transfer register to the stock ledger, in the accounts of both the person transferring the stock and the person to whom the stock is transferred. 1 See Book I. Part VIII, "Stock Records and Stock Transfers"; also Book IV. Ch. Vi. "Stock Certificates," and Ch. VII, "Stock Books." See {43; also Book IV, Form 256. 1088 CORPORATE ACCOUNTING [Bk. III- 56. Transfers and Cancellations of Subscriptions Transfers of stock subscriptions are entered in the subscrip- tion transfer journal, or more simply in the Unissued column of the transfer register, in the same manner as are transfers of certificates, recording name of the subscriber to whom the sub- scription is transferred, the subscription number, and the number of subscribed shaies. Such transfers are posted to the respective individual accounts in the subscription ledger. If a subscription is canceled, no payment having been made, a red ink entry is made on the subscription journal giving the same information as was required at the time of entering the subscription. The red ink entry is considered to have an effect opposite to that of a black ink entry, being deducted instead of added in obtaining the monthly totals, and being posted as a credit on the subscription ledger. If only a part of a sub- scription is canceled, the same procedure is followed for the can- celed part as is outlined above. T bnB 90nBU22l -22 57. Reconciliations Required At the end of each month the shares shown as outstanding in the stock ledger are added. This total must agree with the control in the general ledger; namely, the difference between the Capital Stock Authorized and Capital Stock Unissued accounts. The total of all the balances due as shown by the subscription ledger is then compared with the balance of the Subscriptions to Stock account on the general ledger. The par value of the shares represented by subscriptions on which the stock has not yet been issued, is found and compared with the balance of the Capital Stock Subscribed account of the general ledger. 58. The Instalment Book Stock is sometimes paid for in instalment payments arranged for each individual case, or the subscription contract may pro- vide that certain percentages uniform for all subscriptions shall Ch. 7] STOCK SUBSCRIPTION SYSTEM 1089 Ik come due on predetermined dates, or upon call of the board of directois. The instalment book is used when an instalment of the latter class falls due, or when a call or assessment is decided upon by the board of directors. As will be seen by reference to the form, 4 this book contains a list of the subscribers, the number of shares subscribed by each, and the amount of the instalment due, together with other infor- mation relating to the particular instalment. A new page or sheet is made out for each call or instalment. Instead of re- writing the names foi each of these, the same list may be utilized by ruling up the page with groups of columns, each group adapted for one instalment; or by the use of short pages after the first. This arrangement may cause some little inconvenience in case subscription rights and instalments are transferred, thereby necessitating changes of names. Various methods of handling the instalment book are in use, but that which is most accepted seems to be to consider it as a subsidiary ledger to the Instalment account, discussed in the next section where the relation of the instalment book to the other records is explained. The number in the first column of the instalment book indi- cates the folio of the subscription ledger in- which the subscriber's account is recorded. The figure in the last column preceding the Remarks column indicates the cash book folio to which the payments may be carried in total each day, these payments being credited to Instalment account. Since instalments on subscrip- tions are not necessarily paid on their due date, it is advisable to carry the total of each day's receipts to the cash book, instead of waiting until all are paid. It is obvious that an Instalment account must be opened in the general ledger and charged with the aggregate amount of subscriptions due at that particular date. The same procedure is required for each succeeding instalment. The instalment book is compiled from the subscription ledger See Book IV, Form 255. CORPORATE ACCOUNTING [Bk. III- or from the various subscription sheets or individual subscription blanks, and may be either a bound or loose-leaf book. Loose sheets serve the purpose nicely, since they can afterward be bound together for riling. When subscribers to stock are few in number, the instalment book may be dispensed with; and cash -received on instalments may be entered directly in the cash book, and thence posted to the respective subscribers' accounts in the subscription ledger and in total to the proper account in the general ledger. i.vcfrr \- . 59. The Instalment Account Debit: Hfl-jl With the amount of instalments due by subscribers to shares of stock, the Credit: With payments on account of instalment subscriptions. offsetting credit being to Subscriptions to Stock account. K ri te&fettb , -ma* IVtf^tfD&^o'rrt fcJ<&>Wv^ir;> : This account is employed only when a considerable amount of stock has been subscribed usually at the time the corpora- tion is organized and payment therefor is to be made in instal- ments in fixed amounts and at fixed times or on call. The account is opened afresh each time an instalment falls due. As each instalment is due a credit is made to Subscriptions to Stock, and a debit to the particular instalment, as "Instal- ment No. i, 25%," "Instalment No. 2, 25%," and so on, as the case may be. It shows a debit balance and remains open only until payments on the particular instalment are made. In the case of a close corporation, where the number of indi- vidual subscribers is small, it is often the practice to debit their individual accounts on the general ledger when the subscriptions are originally made (instead of opening a Subscriptions to Stock account), or to debit their accounts with the amount of each instalment as the call is made (instead of opening an Instalment account). If there are many subscribers, this plan is objection- able as encumbering the general ledger with a large number of Ch. 7] STOCK SUBSCRIPTION SYSTEM 1091 stockholders' accounts which could better be contained in a subscription ledger. When the Instalment account is used, its balance must be added to the balance in the Subscriptions to Stock account to ascertain the amount due on subscriptions. The instalment book is a ledger subsidiary to the Instalment account; the sub- scription ledger is subsidiary to the Subscriptions to Stock account. When an instalment is to become due, an entry debiting Instalment and crediting Subscriptions is made on the books for the total amount of the call. This must be credited to the accounts of all the subscribers against whom it applies, thereby keeping the subscription ledger in reconciliation with its controlling account, Subscriptions to Stock. The entry of the charges for the instalment in the instalment book makes the total as shown by that book equal the total as shown by the Instalment account on the general ledger. The payments of the subscribers are credited to Instalment account in total, and in detail to their accounts on the instalment book, maintaining the reconciliation between the instalment book (subsidiary ledger) and Instalment account (control). 60. Stock Sold on Instalments (Plan i) The Lancaster Cement Company was organized June i, 1922, with a capital stock of $1,000,000, one-half of which was subscribed for as follows: Ronald Logan 1,000 shares Samuel Bennett 1,000 i -'*i 1 1 - A. W. Thompson 1,000 " J.H.Connor 1,000 " Oliver Ferguson 1,000 " The terms of subscription are 10% down, 30% on June 21, and the remainder in two instalments as shown by the agreement. The instalment book shows the method of recording calls for instalments. The first call was made by the trustee June i; the second presumably upon final incorporation. 1092 CORPORATE ACCOUNTING [Bk. III- As one-half of the stock was subscribed at the time of organ- ization, this amount may at once be entered upon the books as an asset, since it represents definite obligations due the company. First Entry. June i, 1922 Capital Stock Unissued $1,000,000 To Capital Stock Authorized $1,000,000 Second Entry: Subscriptions to Stock $500,000 To Capital Stock Subscribed '. $500,000 The Lancaster Cement Company was organized on this date with capital stock of $1,000,000, divided into 10,000 shares of the par value of $100 each, one-half of which has been subscribed as per the following list. Terms of subscription are 10% on June i, 1922, 30% on June 21, and the remainder in two instalments as per agreement. Ronald Logan 1,000 shares Samuel Bennett 1,000 " A. W. Thompson 1,000 " J. H. Connor 1,000 " Oliver Ferguson 1,000 " S.ooo 61. Entries for the Instalments The amount subscribed being now entered upon the books, the next step is to make entries for the instalments as they come due, the Instalment account being debited and Subscriptions credited. The accounts of subscribers must be shown either in the subscription ledger, the instalment register, or the general ledger. Sometimes they are placed in the back of the general ledger, but if they are numerous it is advisable to place them in a separate book. Of course, the total of the balances of these accounts must agree with the balance of the Subscriptions account in the general ledger, which is the controlling account. If the number of subscribers is large, an instalment sheet is made out.s See Book IV. Form 255. Ch. 7] STOCK SUBSCRIPTION SYSTEM 1093 Third Entry: June i, 1922 Instalment No. i $50,000 To Subscriptions to Stock $50,000 First instalment for 10% of $500,000 subscriptions, as per subscription list and instalment book. As the payments are made they are credited to the Instalment account. The following entries assume that all the subscribers pay the instalment. If this is not the case, the actual amount received will be entered, leaving a balance due in Instalment No. i. Fourth Entry: June i, 1922 Cash $50,000 To Instalment No. i $50,000 For payment of first instalment of 10%. Fifth Entry: June 21, 1922 Instalment No. 2 $150,000 To Subscriptions to Stock -Pi ''' $150,000 For second call, 30% on total subscriptions of $500,000. Sixth Entry June 21, 1922 Cash $150,000 To Instalment No. 2 $150,000 For payment of second instalment of 30%. 62. Stock Sold on Instalments (Plan i) Ledger Accounts The general ledger accounts resulting from the foregoing entries are as follows: :>{]] u-' .:>;; >,i; : .!>(;; .UV;! '[VMl CAPITAL STOCK AUTHORIZED 1922 June i Authorized $1,000,000 CAPITAL STOCK UNISSUED 1922 June i Authorized $1,000,000 IOQ4 CORPORATE ACCOUNTING CAPITAL STOCK SUBSCRIBED [Bk. III- 1922 June i Subscriptions. . . . $ 500,000 SUBSCRIPTIONS TO STOCK 1922 June i Subscribed. $ 500,000 1922 June i Instalment No. i. 21 Instalment No. 2. INSTALMENT No. i 10% $ 50,000 150,000 1922 June i Subscriptions. ... $ 50,000 1922 June i Cash $ 50,000 (If not all paid a balance will re- sult.) INSTALMENT No. 2 30% 1922 June 21 Subscriptions. . $ 150,000 1922 June 21 Cash $ 150,000 (If not all paid a balance will result.) CASH 1922 June i Instalment No. i. $ 50,000 21 Instalment No. 2. 150,000 If the names are not too numerous or the instalments too frequent, each instalment account might include on the debit side the names of subscribers and the amount due from each; though this is not necessary, as all this information is clearly set forth on the instalment sheet or book. 63. Stock Sold on Instalments (Plan 2) Under the plan, in which a Capital Stock account takes the place of the Capital Stock Authorized and Capital Stock Unis- Ch. 7] STOCK SUBSCRIPTION SYSTEM i95 $50,000 sued accounts, 6 the entries suggested below would be made. It will be recalled that in this case Capital Stock account exhibits only the capital actually contributed, being increased for each instalment paid in, and also for any subsequent sales of stock of original issue. The entry of unissued stock is manifestly out of the question under this plan of entry. June i, 1922 Subscribers $50,000 To Capital Stock -. The Lancaster Cement Company was organized on this date with capital stock of $1,000,000, divided into 10,000 shares of the par value of $100 each, one-half of which has been subscribed as per the list given below. Terms of subscription are 10% on June i, 1922, 30% on June 21, and the remainder in two instalments as per agreement. First instalment, 10% on $500,000, now due. (List of Subscribers) June i, 1922 Cash $50,000 To Subscribers For payment of first instalment. June 21, 1922 Subscribers $150,000 To Capital Stock For second call, 30% of $500,000. June 21, 1922 Cash $150,000 To Subscribers. $50,000 $150,000 $150,000 Payment of second instalment of 30%. If thought advisable, the journal entries might be omitted and, the Subscribers account being eliminated, only cash book entries be made, crediting Capital Stock; but this does not per- mit the full explanation? which can be so conveniently placed in the journal. See I 36. CHAPTER VIII SALE OF STOCK BELOW OR ABOVE PAR /if;lq >l 64. Stock Sold Below Par Stock is sometimes sold on original issue at less than par regardless of the liability for the unpaid balance which attaches to such stock so long as it is in the hands of the original pur- chasers or those who purchase from them with knowledge of the conditions. Attention should, however, be called to the fact that there is a difference between selling stock below par and allowing a commission on the sale of stock, whereby the amount the corporation receives is also reduced.! To illustrate the entries in cases where stock is sold below par, assume that on August 15, 1921, $100,000 of the unissued stock of the Harvard Milling Company is sold to Henry Jones for $80,000, payable $40,000 on date of purchase, and the balance in one month. For the purpose of presenting another method of handling the accounts, it is assumed in this example that no more sales of stock to outsiders are to be made, or that such sales are going to be so few that the corporation prefers the use of individual general ledger accounts to the opening of a subsidiary ledger. The entries are as follows : August 15, 1921 Henry Jones $80,000 Discount on Stock 20,000 To Capital Stock Subscribed $100,000 For sale of 1,000 shares of unissued stock to Henry Jones at $80 per share, payable $40,000 down and the balance in one month. Cash $40,000 To Henry Jones $40,000 First payment on subscription to 1,000 shares of stock. i See I 108. 1006 Ch. 8] SALE OF STOCK BELOW OR ABOVE PAR 1097 September 15, 1921 Cash $40,000 To Henry Jones $40,000 Balance of payment on subscription of 1,000 shares of stock. Capital Stock Subscribed .AviV. . $100,000 To Capital Stock Unissued $100,000 Certificate No. n issued to Henry Jones upon full pay- ment of his subscription. 65. Discount on Stock Account Debit: With the discount on stock sold below its par value. Ot zev/ OMjOK-iq T.)f Credit: With any transfer from this account, by amortization or otherwise, to Surplus or any other account. The debit balance of this account shows the amount of dis- count not written off. Discount on sales of capital stock may be considered a loss, in which case it is of course a capital loss rather than a loss from operations; or, as it is a cost of developing the business which remains as one of the things on which a selling price might theoretically be based, it may be considered an intangible asset partaking somewhat of the nature of good-will. Under the first point of view the practice has been 'to amortize such discounts over a term of five or ten years by annual debits to Surplus or monthly or annual debits to Profit and Loss preferably by the debits to Surplus. In some cases the directors close the Discount account immediately into Surplus, considering it best to remove from the balance sheet what may be considered an undesirable item. The following entry shows such a transfer: Surplus $20,000 To Discount on Stock v - ' ' $20,000 To close Stock Discount account into Surplus entry made by order of the Board of Directors. The above entry will suffice, perhaps, in case the profits are ample to take care of the discount, but nothing is gained if by this disposition a deficit is created in the Surplus account. Under the other point of view, that the discount is not to CORPORATE ACCOUNTING [Bk. Ill- be charged off, it would continue to be carried as an asset, although the account might perhaps be merged into some other by such an entry as: Cost of Development ............................. ....... $20,000 To Discount on Stock ............................. $20,000 To close the latter account. 66. Stock Sold Above Par When a corporation sells its stock at a premium, the proceeds in excess of the par value are credited either to Premium account -or to Paid-in Surplus account, and represent gains, but these, like the losses on stock sold at a discount, are not due to the operation of the business and must not be confused on the books with operating profits. The former practice was to amortize such premiums over a period of five or ten years by monthly or yearly credits to Profit and Loss, but on account of income tax laws it is desirable to avoid any plan which will make it less easy to determine the sources of surplus. The preferred present practice is to retain the Premium account as a classification of Surplus, 2 or to credit the entire balance in the account to Surplus at one time, usually when all the stock which is being offered has been sold. The latter practice is general in banks and other corporations where it is the practice to sell stock at a premium even at the time of organization^ The Premium on Capital Stock account is the same account which was earlier discussed and its functions given under the name of "Paid-in or Contributed Surplus." 4 Discounts on sales of capital stock, if less than the amount of premium earned on other sales, should eventually be closed from the Discount ac- count into this account. In case the Premium account is closed into Surplus, when, as is the case with banks, surplus means premium, or when, as in many other institutions, the advisability of maintaining the 2 See Ch. IV, "Classification of Surplus.'' 3 See also 68. See { 24. Ch. 8] SALE OF STOCK BELOW OR ABOVE PAR 1099 surplus-classification accounts has not been realized, or in case it is closed by the older method into Profit and Loss, Premium account would of course be debited and the account to which it is transferred be credited. 67. Accounting Treatment of Premiums To illustrate the accounting treatment of premiums, assume that $100,000 face value of the unsubscribed stock of the Harvard Milling Company has been sold November i, 1921, to George Bowers for $120,000, payable $50,000 at date of purchase and the balance in one month. The entries for the transaction would be as follows: November i, 1921 George Bowers (or Subscriptions) $120,000 To Capital Stock Subscribed .'. ... . . . ." $100,000 Stock Premium .' ['. '' 20,000 The Harvard Milling Company has this day sold to George Bowers $100,000 of its unissued stock for $120,000; $50,000 is payable on the day of purchase, and the balance in 30 days. Cash $50,000 To George Bowers $50,000 First payment on account of subscription to stock. December i, 1921 Cash $70,000 To George Bowers $70,000 Balance due on account of subscription to stock. 68. Stock Issued at a Premium to Create a Surplus In the previous illustration the stock of an established company was sold at a premium. As already stated, it is not unusual for a corporation to sell its stock above par at the time of incorporation, for the purpose of creating a surplus a practice which is usually followed by insurance companies, banks, trust companies, and other financial institutions. A company with a substantial surplus is more likely to possess the confidence of 1 100 CORPORATE ACCOUNTING [Bk. III- the public than one that has none; and by selling stock at a premium a more or less substantial surplus or margin is provided at the outset, which may be drawn upon to meet organization expenses, and carry the company and give it solidity until it becomes firmly established. When stock is thus sold at a premium, the entries are the same as in any other sale above par. For example, if a share of stock is sold for $150, its par value of $100 might be credited to Unissued Stock or Capital Stock, and the $50 to Premium or Surplus. There are material advantages in this plan of selling stock, especially in the case of a national bank, where a double liability is attached by statute to every share of its stock. If the stock is sold at a premium sufficient to meet the statutory liability, not only is this liability provided against, but the bank is given a substantial and desirable addition to its working capital. In any such case the premium is credited to Surplus. Thus, assume that the Second National Bank of Shawmut has been incorporated with a capital stock of $250,000, all of which has been sold at a premium of 50%. The book entry would appear as follows: Cash $375,000 To Capital Stock $250,000 Surplus 125,000 The Second National Bank of Shawmut, incorporated with capital stock of $250,000, has on this date sold it at a premium of 50%. This contributed surplus remains on the books as a credit to Surplus account. CHAPTER IX TREASURY STOCK WITH A PAR VALUE 69. Definition The term "treasury stock" is, strictly speaking, limited to stock which has once been issued for value and which through purchase or gift has been returned to the possession of the issuing company. The unissued stock of a corporation should not be called treasury stock. 1 70. Treasury Stock Account 2 Debit: With the par value of stock issued by a corporation and subsequently repur- chased by it. Credit: With the par value of treasury stock sold or retired by a reduction in the amount of authorization. Although the practice was formerly different, the principle seems now to be accepted that the debit to Treasury Stock account for the repurchase of a corporation's own stock should be for the par value of the stock irrespective of the purchase price. The necessary entries are shown below. Although the balance of the Treasury Stock account is a debit, treasury stock cannot be considered an asset similar to stock of another corporation. The acquirement of treasury stock is a reduction, for the time at least, of the amount of capital stock outstanding, and should be shown on the balance sheet as a deduction from capital; thus: r >)?>< >dT .oJon n fjjOD-jnju: rbiriv/ 1, [Jr. Capital Stock $200,000 Less Stock in Treasury 25,000 Outstanding $175,000 1 For technical discussion of treasury stock, see Book I, Ch. XIII, "Treasury Stock." 1 Separate account for each class of treasury stock owned. 1 102 CORPORATE ACCOUNTING [Bk. XII- When treasury stock is carried on the books in any other way than at par, this offset cannot be made without taking into consideration facts not shown in the trial balance. If the above treasury stock with a par value of $25,000 had been purchased for $20,000 and entered on the books at cost, the deduction of $20,000 from the capital stock would show an erroneous amount of outstanding stock. Treasury stock includes donated stock, which is discussed separately in the following chapter. In the present chapter only repurchased stock is considered. 71. Entries for Purchase at Par or at a Discount To illustrate the accounting treatment of purchases of a company's own stock, suppose that it repurchases at par 500 shares of its fully paid stock. If par is $100 per share, the entry will be: Treasury Stock $50,000 To Cash $50,000 500 shares of this company's stock purchased from H. T. Jeffries, certificates Nos. 123 and 124 being surrendered. Transactions in treasury stock when the purchase price is not par involve certain complications. The mere fact that a corporation repurchases its stock at a discount does not imply that a profit has been made and that Surplus should be credited with the amount of the discount. Until the stock is sold at a higher price than that which is paid there is no realized profit, and unless the stock can be shown to be unquestionably worth more than it cost, the discount does not represent any profit at all of which an accountant could take note. The best treatment of the discount is to credit it to an account known as "Con- tingent Profit on Stock," or by some other name which will clearly indicate that it is not a realized or even a certain profit. The proper entry, then, for the purchase for $10,000 of stock with a par value of $15,000, would be: Ch. 9] TREASURY STOCK WITH A PAR VALUE 1103 Treasury Stock $15,000 To Cash $10,000 Contingent Profit on Stock 5,000 (With the necessary explanation.) '.'. . ' rieii' ) 72. Contingent Profit on Stock Account Debit: With the amount credited to this account at the time of the purchase of treasury stock, this entry to be made at the time of selling the stock. Credit: With the discount at which treasury stock is bought. rhjslirnia > The credit balance of the account shows the difference be- tween the par value and the purchase price of stock repurchased at a discount and still held. To maintain this condition on the books it is necessary, at the time of every sale of treasury stock, to debit Contingent Profit on Stock with the amount credited to the account at the time of making the purchase. 73. Entries for Sale of Treasury Stock Purchased at a Discount If the $15,000 par of stock shown above as having been purchased for $10,000 were sold for $10,000, the entry, just the reverse of that previously made, would be: Cash $10,000 Contingent Profit on Stock 5,000 To Treasury Stock $15,000 If it were sold for par the entry would be : Cash ' ?*?. *t.. $15,000 Contingent Profit on Stock 4 fW.ni \< 5oo To Treasury Stock $15,000 Surplus '. .. 5,ooo HE z&A .nod*nom; aui. VLwr, PAR-VALUE DONATED STOCK 76. General Conditions In speculative companies, donations of stock to the treasury are customary, and give rise to some of the most unsatisfactory entries of corporate bookkeeping. Any donation to a commercial undertaking is anomalous, but when it takes the form of stock just issued (and hence of unknown value) by the very corporation to which it is donated, the transaction is entirely outside the realm of ordinary business and its proper entry is difficult. The usual object of such a donation of stock is to furnish the newly organized company with stock which can be sold below par without carrying with it a liability. Treasury stock supplies this need, and so long as the laws relating to full-paid stock exist in their present form, so long will transactions in donated stock continue. 1 When a corporation reacquires its own stock by donation, this stock becomes, from the accounting standpoint, an asset of a type exactly similar to repurchased stock, 2 and is frequently debited to Treasury Stock account. Many authorities, how- ever, consider it advisable to separate on the books the trans- actions in stock purchased and stock donated, and recommend carrying the latter in a Donated Stock account. There is, however, no really serious objection to the other practice. 77. Reasons for Donation of Stock There are two principal reasons for the donation of a corpora- tion's own stock to it by its stockholders. These are: (i) that 1 Under the laws permitting corporations to issue stock without par value, stock so issued may by proper procedure be sold at any desired price without liability. See Book I, Ch. XII, "Full-Paid Stock," and Ch. XV, "Advantages of No-Par-Value Stock." * See { 70. 1106 Cn. 10] PAR-VALUE DONATED STOCK 1107 it may sell all or part of the donated stock and thus provide working capital with which to operate a business; and (2) to cover losses that have already been sustained, thus wiping out a deficit or changing it into a surplus. The first condition arises from the fact that when a mine, an oil well, or some similar property is turned over to a corpora- tion by a promoter, it is a common practice to issue to the promoter the entire capital stock of the corporation in full payment for the property. The corporation then has no more stock to sell for the purpose of providing working capital and developing the property, but as the promoter's stock will have no sale value unless the property is developed, he donates to the corporation a part of the stock which had been issued to him. This stock is sold as a means of raising working capital. The stock so donated back was fully paid by the transfer of the property from the promoter to the corporation, but if the prop- erty acquired with the stock had really been worth the par value of the stock, the donation would represent a profit and would be a legitimate credit to Surplus. The fact that the promoter im- mediately donates back a part of the stock given him shows. IT- however, that the price was excessive. '<> !"iJ> - 1 ! DflJi Stock is also donated back to the corporation at times when the business has been operated at a loss with a resulting deficit. The stockholders may agree to an assessment, or those most heavily interested may make a donation which is not pro rata against all the stockholders. In either case the gift of stock may be sold immediately if the business needs ready money, or it may be held as treasury stock until the operating profits justify its return by a stock dividend. The present practice is to carry donated stock on the books at par, for the same reasons for which other treasury stock is carried at par. 8 The former rule of estimating its market value and carrying it at that figure has come into disfavor. 1 See I 70. II08 CORPORATE ACCOUNTING 78. Donated Stock Account < [Bk. III. Debit: With the par value of shares donated With the par value of shares of to the treasury. donated stock sold, or retired by a reduction in the amount of capital stock authorized. As has been said earlier in the chapter, the functions of this account may be included in the scope of the Treasury Stock account, instead of opening a Donated Stock account. 79. Donated Surplus Account Credit: With the par value of stock donated back to the company, the offsetting debit being to Donated Stock account. With the excess when donated stock is sold for more than the value at which it was credited to this account. Debit: With the discount on donated stock sold below the value at which it was credited to this account, and with any expense in connection with such sale. With the amount transferred at any time to a general Surplus account, as a result of gain by sale of stock donated The balance of this account also known as Donation or Working Capital Donated account is always on the credit side and is an offset to Donated Stock account. Donated Surplus is credited with the par value of donated stock in the entry in which Donated Stock is debited. As donated stock is sold and the amount of the donation realized thereby, such profit, after deducting any expenses, may be carried to Profit and Loss or to a general Surplus account, or else be permitted to remain in Donation account until all of this stock is disposed of. It may then be closed off as suggested, or be permitted to stand as a credit balance to the account. 5 80. Entries for Donated Stock (First Method) If a corporation is organized with a capital stock of $75^000, all of which is issued in payment for property, and stock of the 4 Separate account for each class of stock donated. * See | 28. Ch. 10] PAR- VALUE DONATED STOCK IIOQ face value of $10,000 is returned to the company to be sold to secure operating capital, the entries will be as follows: Donated Stock $10,000 To Donation : $10,000 Stock donation of 100 shares to be sold to provide working capital. If the stock is sold at par the following entry is required: Cash $10,000 To Donated Stock $10,000 For 100 shares of treasury stock sold at $100 per share. The Donation account may then be closed into a general Surplus account as follows : Donation $10,000 To Surplus $10,000 Closing Donation account into Surplus. If, however, the stock when sold produced more than par, say $110 per share, the cash entry would be as follows: Cash $i 1,000 To Donated Stock ... . $10,000 T-. Donation 1,000 For 100 shares of stock donated to treasury and sold at $110 per share. This gives a total credit in Donation account of $11,000, which is the amount actually realized on the donated stock. Donation account may then be closed into Surplus by a journal entry. If on the other hand the treasury stock is sold at less than par, say for instance, $40 per share, the cash entry would be as follows: Cash $4,000 Donation 6,000 To Donated Stock $10,000 For 100 shares donated to treasury and sold at $40 per share. This shows a credit balance in Donation account of $4,000, which is the real value of the stock donated, and the account may then be closed into Surplus. 1 1 10 CORPORATE ACCOUNTING [Bk. III- The objectioii to the above method of recording -donated stock lies in the fact that it shows an apparent profit before active corporate operations have begun, or even before the company has become well established. At this stage, when the corporation's sole assets are the property taken over and the stock which has been donated to it (the value of which really rests upon this same property), any profits shown could hardly be other than fictitious; certainly not unless the property for which the stock was originally issued was actually worth as much as or more than the face value of the stock, in which case a real profit from donated stock would result. In practice, the value of property taken over by a corporation for stock is seldom con- servatively estimated, and the apparent profits from donated stock are usually fictitious and misleading. 81. Entries for Donated Stock (Second Method) Under the second method of entry, the donation of stock is considered as a concession on the price of the property for which it was issued, and the value of the returned stock is accordingly credited to this same property account. This reduces the book cost of the property to the corporation, but does not show the immediate and usually fictitious profit that is shown by the first method of entry. The method is therefore more conservative than the one first presented, and is to be preferred as putting on the books a more correct valuation of the assets secured for the stock. Thus, if a corporation is formed with a capital stock of $100,000, all of which is issued in payment for patent rights, the entry would be as follows: Patent Rights $100,000 To Capita] Stock $100,000 Entire capital stock issued in exchange for patent rights. See page .... of minute book. If $25,000 face value of this stock is then returned to the treasury, it is credited to Patent Rights at par, the entry being as follows: Ch. 10] PAR-VALUE DONATED STOCK III! Donated Stock $25,000 To Patent Rights .r w $25,000 For 250 shares of stock donated to treasury for purposes of the corporation. If this stock is sold at par the cash entry would be as follows : Cash $25,000 To Donated Stock $25,000 For 250 shares of donated stock sold at par. If, however, the stock should sell at more than par, say at $no per share, the excess must go to Patent Rights in order to show the true rebate or concession made on the price. The entry would therefore be as follows: Cash $27,500 To Donated Stock $25,000 Patent Rights 2,500 For 250 shares of donated stock sold at $110 per share. Originally credited to Patent Rights at par. Likewise, if the stock sold at less than par, say at $40, the deficiency is debited to Patent Rights, as follows: Cash $10,000 Patent Rights 15,000 To Donated Stock $25,000 For 250 shares of donated stock sold at $40 per share, originally credited to Patent Rights at par. By this method the book value of the intangibles for which the stock was originally issued is reduced by the amount realized from the sale of the stock donated back to the company. 82. Entries for Donated Stock (Third Method) There is a third method of handling such transactions as this, which in theory is a compromise between the other two. By it Patent Rights would first be credited with the par value of the donated stock, but the sale of the donated stock is treated as would be any other sale of treasury stock, no further change being made in the value of the Patent Rights on account of the donation. III2 CORPORATE ACCOUNTING [Bk. III- Under this method the entries for recording the first issuance and donation which we have just considered would be, as before : Patent Rights $100,000 To Capital Stock $100,000 Entire capital stock issued in exchange for patent rights. See page .... of minute book. Donated Stock $25,000 To Patent Rights $25,000 For 250 shares of stock donated to treasury for purposes of the corporation. ,. . . '.i ' . The entries for the sale of the stock would be as follows: // sold at par: Cash $25,000 To Donated Stock $25,000 ."(':'< I 1, '. If sold at $80: Cash $20,000 Discount on Donated Stock 5,000 To Donated Stock $25,000 // sold at $120: Cash $30,000 To Donated Stock $25,000 Surplus 5,ooo 83. Advantage of Second and Third Methods The advantage of the second and third methods of handling donated stock lies in their more conservative presentation of the cost of the intangibles. The objection is urged against these methods, however, that the entry may by inference cast some reflection upon the directors' usual statement in their resolution of acceptance, that the property "is of the reasonable value of the stock issued therefor." This is a matter for the treasurer of the corporation and the directors to consider and decide for themselves. ari s'u; - I I, o<-'r J^/^s frlf rl'iir4*ju -Tfl i>vi< *(4i (M u<- -r 1 f f i CHAPTER XI totulcib lq[ v'ffjrn;, [H jqqj; -pnobn-Ji 'jm srfT .aaiurie sutey-iBq riirw 85. Entries at Actual Value If the stock is to be handled through the books at the amount which it actually brings to the company if, in other words, the Capital Stock account is to show the amount of capital actually invested the handling of transactions in no-par stock is much simpler than that of dealings in stock with a par value. There is, in the first place, no need of the Capital Stock Authorized and Capital Stock Unissued accounts. Certificates of stock without par value indicate simply the undivided interest of the holder in the net worth of the corporation, according to the number of shares held, and it is the ratio of the number of shares held by the individual to the total number outstanding which indicates his proportionate share. The general books, however, deal in money values and not in shares or ratios, so that the Capital Stock account 2 shows in its money columns which alone enter into the trial balance only the amount paid in on stock and deductions therefrom. The functions of the account are: * Cf. I 36. Ch. n] CAPITAL STOCK WITHOUT PAR VALUE CAPITAL STOCK Debit: With the price at which shares retired were credited to this account when sold. Credit: With the sale price of the shares issued. The corresponding debit is to Cash, to the proper property account, or to Subscriptions to Stock, as the case may be. 86. Opening Entries For the reason that it is impossible in the case of no-par stock to indicate the authorized capital of the corporation by such a journal entry as is used in setting up the authorization for par- value stock, a pro forma statement 3 is really of more value with no-par than with par-value stock. The opening journal entry will show the subscriptions for stock first received. The Mohawk Automobile Company was incorporated on March i, 1922, with an authorized capital of 100,000 shares without par value. At the time of incorporation 10,000 shares were subscribed for at $20 per share, of which one-half was paid down in cash and the balance two months later. On May i, 10,000 additional shares were sold for cash at $25 per share. The first entries to be made on the books of the company will show the subscriptions to stock. The credit will be given to Capital Stock if the subscriptions are paid in full, or to Capital Stock Subscribed if they are paid only in part and the certificates are not to be issued immediately. The entries are as follows: March i, 1922 Subscriptions to Stock $200,000 To Capital Stock Subscribed $200,000 The Mohawk Automobile Company has this day been organized with an authorized capital of 100,000 shares without nominal or par value. Subscriptions for *. I , y.; i . , 10,000 shares at $20 each, payable one-half down and the balance in two months, have been received from: (itst). > See i 32. lll6 CORPORATE ACCOUNTING [Bk. Ill- Cash $100,000 To Subscriptions to Stock $100,000 (Full explanation here.) May i, 1922 cash ;:.?:;: i .j...:';, $100,000 To Subscriptions to Stock .'!'.'. .'. '. ! '. . . $100,000 (Full explanation here.) Capital Stock Subscribed $200,000 To Capital Stock $200,000 Certificates Nos issued to , their subscriptions having been paid in full. Cash $250,000 To Capital Stock $250,000 For sale and issuance of 10,000 shares of the remaining stock at $25 per share cash. The later subscription might if desired have been passed through the Subscriptions account, like the former, but the only advantage would be uniformity in practice. There is also no need of carrying it through the Capital Stock Subscribed account, as the stock is immediately issued. There are now 20,000 shares of stock outstanding on which $450,000 has been paid, giving each an average book value of $22.50 notwithstanding the fact that one-half were sold at $20 per share and the remainder at $25. Each share of no-par-value stock is "equal to any other share of such stock subject to prefer- ences given to the preferred stock if any authorized be issued." 4 This is as it should be, because the original purchasers of stock have to take the chance of winning or losing in a newly organized corporation, and when a surplus has been accumulated the in- coming stockholders should be required to pay therefor. The sale price is by the laws of most states left to the directors, or the stockholders, or is fixed by the law of supply and demand. 87. Subsidiary Records The same records are used in a subsidiary way for transactions in no-par stock as for transactions in stock with a par value. The Laws of 1912, N. Y., Sec. 19. Ch. n] CAPITAL STOCK WITHOUT PAR VALUE III? certificate stubs, the stock ledger, the subscription ledger, the instalment sheets all these have their functions and are used in the same manner. Corporations with par- value stock are able to tell the number of outstanding shares by subtracting the debit balance of the Capital Stock Unissued account from the credit balance of the Capital Stock Authorized account, and dividing the difference by the par value of the stock. But that is impossible with stock of no par value. In the case just considered the Capital Stock account shows a balance of $450,000, the amount received for the stock outstanding. To find out how many shares this repre- sents it is necessary to trace back the individual transactions, unless there is accumulated on the ledger page of the Capital Stock account not only the amounts of money received for the stock, but also the number of shares issued therefor, in some such manner as the following: CAPITAL STOCK 1922 Mar. (Authorized 100,000 shares, no nominal or par value) May 10,000 shares at $20 ... 10,000 shares at $25 . . . $200,000 250,000 The aggregate of shares thus issued is the control for the certificate stubs. The same plan might be followed with the Capital Stock Subscribed account, in which the difference between the share totals would show the amount of stock reserved for subscribers and not issued. In the present instance the ledger sheet of this account would, for the first transaction, show the following information: CAPITAL STOCK SUBSCRIBED 1922 May i Issued, 10,000 shares. $200,000 1922 Mar. i Subscribed, 10,000 shares ...:'..'' -' - $200,000 CORPORATE ACCOUNTING [Bk. III- 88. Earned Surplus of Corporations with No-Par Stock The earnings of corporations with no-par stock should be carried through the Surplus account just as are the earnings of corporations whose stock has a par value. As stated earlier in the chapter, when the practice of giving the stock a stated value is followed, this surplus should be carried in an account distinct from the capital surplus resulting from the sale of stock at a price above its stated value. It was formerly argued that when stock is issued without par value and there is only one class of stock, all outstanding, there is no necessity for making a division between the Capital Stock and Surplus accounts, since both the proceeds of the sale of stock and the net profits of each fiscal period might be entered in a Capital account. Such -an account would thus be credited with the amount of capital paid in and the accumulation of profits, and be debited with the distribution of dividends. The theory underlying this argument is that the very purpose of no- par stock is to avoid artificial valuations on the books, showing a true value instead of separating the paid-in capital and the earnings. Under this plan the Capital account would change from year to year, or each time the books are closed, like the capital of a partnership. The net amount credited to Capital divided by the total number of shares .outstanding would give the book value per share. It is now, however, an accepted principle of no-par-stock accounting that a differentiation should be made between the amount paid hi for no-par stock (to be credited to the Capital Stock account just as for stock of a par value), and earnings (carried to the Surplus account). When this is done the book value of the stock is found by adding the balances of Capital and Surplus accounts, and dividing the sum by the total number of shares outstanding. The separation of contributed capital and surplus is valuable for statistical purposes, and is essential in guarding against the impairment of capital by the payment of excessive dividends. To avoid this it is necessary to know Ch. nj CAPITAL STOCK WITHOUT PAR VALUE how much of the net worth is the contributed capital, and how much is surplus available for dividends. In the case of corporations which have issued both stock bearing a par value and stock without par value, the profits must be shown separately because they belong to both. For such corporations the combination of surplus with contributed capital on the books would manifestly be unwise. In summary, then, it may be said that the Surplus account of corporations with no-par-value stock should be handled like that of corporations with par-value stock. . f [ D ' t ;> fti ., loiJiMu! m >h-J3 89. Some Accounts Not Used for No-Par Stock Except that a single Capital Stock account is always used in place of the Capital Stock Authorized and Capital Stock Unis- sued accounts, it may be said that the functions of all the accounts used in handling capital stock transactions are the same for no-par transactions as for those in par-value stock. But there are several accounts used in connection with the proper recording of par-value stock that are not necessary when the stock has no par value. The Discount on Capital Stock and Premium on Capital Stock accounts, for example, find no use in no-par accounts unless the stock is handled on the books at a nominal or stated value, in which case the transactions will be entered just as are transactions in par-value stock. 90. No-Par-Value Preferred Stock No-par preferred stock may be handled just as is no-par common stock, in spite of the fact that no-par preferred shares have a "declared" value more frequently than have no-par common shares, due to the fact that if the preferred issue has preference as to assets, the certificates for the preferred stock must of course show the amount which the holder of each share of preferred stock is entitled to receive upon liquidation. While for liquidation purposes such a declared value as that above suggested is considered equivalent to a par value, yet it 1 1 20 CORPORATE ACCOUNTING [Bk. III- is not necessary to carry the stock on the books at the stated value. Such a course, however, is more justifiable in the case of stock preferred as to assets than in the case of common or other preferred stock, as the Preferred Stock account will thus show the value at which it must be liquidated, while the Common Stock and Surplus accounts will show the book value of the common stock. 91. Shares With and Without Par Value A company may be authorized to issue par-value preferred stock in addition to no-par-value common stock. In such cases the books will handle the preferred under the rules laid down for par- value stock, and the no-par common like any other no-par stock, just as if there were no complication on account of par- value preferred. The following example illustrates the incor- poration of a company with par-value preferred stock and no-par common stock, part of this stock exchanged for property. The Brazil Copper Mining Company is incorporated with a capital of 10,000 shares of common stock without par value, and 10,000 shares of preferred stock with par value. of $100 each. One thousand shares of the common stock have been sold for $25 each and 1,000 shares of the preferred at par, both paid in cash. The following properties were purchased with the remain- ing unissued common stock: Mine $200,000 Construction and Equipment 50,000 Development Costs 27,000 Materials and Supplies 25,000 Ore Mined and on Hand 40,000 The opening entries are as follows: Cash $25,000 To Common Stock $25,000 Being full payment in cash of 1,000 shares of common stock of the company incorporated this day with an authorization of 10,000 shares of common stock without par value and 10,000 shares of preferred stock with a par value of $100 each. Ch. n] CAPITAL STOCK WITHOUT PAR VALUE 1121 Cash $100,000 To Preferred Stock $100,000 Being full payment in cash of 1,000 shares at $100 each of the preferred stock of the company. It now remains to complete the transfer of the properties to the company in the manner necessary to insure clear title, etc., and to issue in full payment therefor the remaining 9,000 shares of unissued common stock. The journal entry to record the matter on the company's books is: Mine $200,000 Construction and Equipment 50,000 Development Costs 27,000 Materials and Supplies 25,000 Ore Mined 40,000 To Common Stock i j . $342,000 Mine, construction and equipment, development costs, material and supplies, and ore purchased this day by the Company, in payment for which there have been issued 9,000 shares of common stock of no par value. 92. Ease of Inflation of Values It will be seen that the stock issued in payment for the property is on the basis of $38 per share, or a total of $342,000. This is $13 per share more than the sale price of the original 1,000 shares. The entire outstanding common stock now has an average book value of $36.70 per share, or a total of $367,000. Presumably the stock will be carried on the books at this figure. If, however, contrary to good practice, it should be carried at a "stated value" of, say, $25 per share, $225,000 would be credited to Capital Stock, and $117,000 to Capital Surplus. The value of assets purchased with par-value stock is pre- sumably the same as the par value of the stock issued in exchange for them. This indication of value is, however, wanting when assets are purchased with no-par stock at least in the case of a new corporation where the book value of its stock has not been fixed by transactions with known values, as where the stock is sold for cash. In any such case no-par stock does not express 1 1 22 CORPORATE ACCOUNTING [Bk. III- itself In definite money amounts, but only in the number of shares issued, to which no distinct money value is attached. Any desired value can then be placed on the assets purchased with no-par stock, and the book value of the outstanding no-par stock will be fixed thereby. The ease with which values can thus be expanded without liability to those holding the stock exchanged for such assets, leads one to wonder whether, after all, the no-value shares are not likely to be used as a convenient accessory for inflating values. Against this objection, however, it may be asked how often assets acquired with par-value stock are really worth the par value of the stock issued therefor. 93. Change from Par- Value to No-Par Stock (Plan i) The entries to record on the books of account the change, by charter amendment, from par-value stock to stock of no par are an interesting study. Let us consider the following case: A corporation with $100,000 of common stock outstanding, par being $100 per share, has accumulated a surplus of $75,000, of which $25,000 was premium paid on the stock. This cor- poration changes its charter so that its authorized capital becomes 10,000 shares of no-par value, of which it proposes to issue 2,000 pro rata to the holders of its par- value stock. Under the first plan for recording the transfer the entry would be as follows: Capital Stock $100,000 Surplus 25,000 To Capital Stock $125,000 Entry made to show the effect of a charter amendment appearing on page of the minute book, whereby the former issue of capital stock, of a par value of $100,000, which had been sold with a total premium of $25,000, is canceled, and 2,000 shares of the newly authorized no-par stock are issued therefor. The former Capital Stock account is closed and a new one is opened with the amount which the corporation origi- nally received for the stock superseded by the new issue Ch. u] CAPITAL STOCK WITHOUT PAR VALUE 1123 94. Change from Par- Value to No-Par Stock (Plan 2) The entries under the second plan for recording this change from par- value to no-par stock would be as follows : Capital Stock $100,000 To Capital Stock , $100,000 Recording the cancellation of the former issue of capital stock, and closing the former Capital Stock account to show the effect of a charter amendment recorded on page .... of the minute book, and opening a new Capital Stock account which is credited with the 2,000 shares issued in exchange for the old. The theory underlying this plan is that the new stock exactly takes the place of the old, and that the fact that a total premium of $25,000 had been received on the old does not enter into the case, the premium having gone into Surplus. The argument applies especially to a corporation which has sold its stock at a premium but which now, due to the declaration of large divi- dends, has no surplus against which to charge the premium formerly received. In such a case the entry under the first method would show an impairment of capital at the very start, although the declaration of dividends covering the premium did not impair capital since par had been received for the stock. The second method, in such a case, seems immeasurably bet- ter than the first. The charter amendment creates new condi- tions, and it is only proper that the equivalent legal conditions should be applied to the record of these new conditions. The courts will eventually decide which is the proper valuation to place on the stock, 95. Change from Par- Value to No-Par Stock (Plan 3) If, then, we are going to use a figure other than the amount which the company actually received as being the amount of the credit to Capital Stock account for the stock of no par value issued in exchange, why not, ask some, take its book value? Why not, in other words, credit the Capital Stock account with 1 1 24 CORPORATE ACCOUNTING [Bk. III- the book value of the stock which is being retired, namely, the net worth of the corporation or the sum of its Capital Stock and Surplus accounts? If this were done the entry would be : Capital Stock $100,000 Surplus 75,ooo To Capital Stock $i 75,000 (Full explanation here.) The objection to this method, which at first glance may seem the most logical, is that by it the amount of accumulated surplus is made a part of the capital of the corporation, and cannot there- after be declared in dividends without having the books show an impairment of capital. 96. Change from Par- Value to No-Par Stock (Plan 4) A compromise plan has been suggested, whereby the first method would be used in all cases in which a surplus existed against which the premium might be charged. Under this plan, if the surplus was insufficient to cover the entire amount of the premium, whatever there was would be canceled, so that the amount of the credit to the new Capital Stock account would be the par value of the original stock plus the amount of any premium still left in the company's possession. If a stated value is to be used, the excess of the original sale price over the stated value, plus any premium still undistributed in dividends, would be credited to Capital Surplus. This method is subject, though in a less degree, to the same objections as is the third plan, in that it removes from the surplus available for dividends a certain amount. It might often justly be insisted that the entire amount of the premium had long before been distributed as dividends, and that what was now in Surplus account was earned profits, which no act of an accountant could prevent from being available for dividends, and which no act of an accountant should so show as to indicate an impairment of capital if it was declared in dividends. Ch. n] CAPITAL STOCK WITHOUT PAR VALUE 1125 97. Increase or Reduction in Authorization Since, in dealing with stock of no par value, the amount of the authorized capital stock is not set up, no entries are needed to record an increase in the amount authorized for issue. In the same way no entries are needed to show the amount of a reduc- tion in the authorization, unless to accomplish the reduction it is necessary to call in and cancel outstanding stock because there is more stock outstanding than is authorized after the reduction. In the latter case the methods laid down in Part VI would be followed. 9i9ii) Jud ,iov fil vlifinigho *fcw 3r rbjil-w j 98. No-Par Treasury Stock The principle followed in the accounting for par-value treasury stock 5 was that such stock should be carried on the books at par in order that it might properly be offset against the total issued stock (which is also carried at par), because the repurchase of a corporation's own stock is in reality a reduction of the capital, at least temporarily. Applying this same prin- ciple to no-par stock, treasury stock should be entered on the books at the price at which it was originally credited to the Capi- tal Stock account. L irf Stock of no par value, like par-value stock, may be repur- chased by the issuing corporation at a price differing from that at which it was originally issued. If it is repurchased above that price, the difference will be a reduction in the surplus avail- able for dividends, and will be debited to Surplus account just as in the case of par-value stock. It is especially necessary in the case of no-par stock to exercise great care to see that the contributed capital is never encroached on in distributions of surplus through dividends; and exact entries of the purchase price of treasury stock are vital on this account in order that the Surplus account as well as the Capital Stock account may reflect the true conditions. No-par treasury stock repurchased at less than its original . - o 1 1 26 CORPORATE ACCOUNTING [Bk. Ill- Sale price must, in the same way, be carried on the books at the original sale price in order that the Capital Stock account may, after the balance in the Treasury Stock account has been offset against it, show the amount originally received for the stock which is outstanding. The difference between the original sale price and the repurchase price, or discount at which it was rebought, may, as in the case of par-value stock, be credited to Contingent Profit on Treasury Stock, 6 or may be considered as creating a paid-in surplus. The above principle of entering treasury stock at the value at which it was originally issued is in greatest favor, but there is another theory which has some adherents. If different blocks of no-par stock are issued at various prices, the Capital Stock account at any time divided by the number of shares then outstanding gives the average issuance price of all stock. In the case of the Brazil Copper Mining Company this value was $36.70. There are those who favor bringing treasury stock into the books at this figure. Since, however, more of the unissued stock 7 might later be sold at a price which would result in still another average, this method does not stabilize book entries as it might seem to do; and whether such average values should be used in the determination of the effect on surplus of the repurchase of stock or whether for this purpose one should use the price at which the particular shares reacquired were issued is a debatable point which will probably not be finally decided ' until the courts pass on some case of impaired capital. The entries for the sale of no-par treasury stock will be made in the same manner as for the sale of par-value treasury stock, except that the credit to Treasury Stock account will always be the amount at which the stock sold is carried in that account. 99. No-Par Donated Stock Donated stock of no par value is proportionately of less frequent occurrence than is the case with par-value stock since See J 72. 7 In this particular example the full authorized amount was issued. Ch. n] CAPITAL STOCK WITHOUT PAR VALUE 1127 there are not such pressing reasons for the donation of stock to no-par companies. 8 For the same reason the principles under- lying its handling are somewhat different. The best practice seems to be not to enter the donation in money terms until the stock is sold, making only those memorandum entries which are necessary to keep track of the shares donated back. Such an entry would be: Donated Stock $ none To Capital Stock $ none Stock donation of 100 shares to be sold to provide working capital. . The number of shares so donated would be entered in the description columns of both the Donated Stock and Capital Stock accounts. For recording the sale of par-value donated stock we found three methods accepted, only the first two of which will apply to no-par stock. The proceeds of the sale of donated stock of no par value may be credited either to Donated Surplus or, if the stock was originally issued for an intangible such as patent rights, to the account which was originally debited when the stock was issued. The latter plan is preferred when it is appli- cable, because it places a more conservative value on the intangi- bles, which were hardly worth the value at which they were bought if the vendor donates back to the company some of the stock he received for them. -'.it '(> ' See 176, 77. ^baoo -^i^, ;^.r orfi CHAPTER XII NON-STOCK CORPORATIONS 100. General Nature Corporations whose capital is not represented by shares of stock are generally organized for the attainment of special ends which are not financial, rather than for the pecuniary benefit of their members. Many religious, charitable, educational, li- brary, social, and benevolent bodies are organized in this way. These comprise churches, hospitals, asylums, homes of various kinds, educational institutions, clubs, associations, etc. Among them will be found associations of a professional nature or for the betterment of their members, such as fine arts clubs, literary, medical, and scientific societies; or of a philanthropic or public nature, such as the Red Cross and other organizations which became so prominent in welfare work during the Great War. Non-stock corporations are usually organized and established by public-spirited men and women who contribute funds for their establishment. A hospital may be established by a single individual or by relatives and friends as a memorial, or it may be built up by the contributions of many. The money or property subscribed constitutes the capital of the corporation. Sometimes money is borrowed temporarily or more permanently through the issuance of notes or mortgage bonds. Men and women frequently specify in their wills that upon their death certain legacies shall be paid over to designated organizations, or that certain trusts shall be established for the benefit of particular activities. These are common occurrences in all parts of the country. Probably the greatest non-stock organization of this kind is the Rockefeller Foundation, the object of which is to render assistance wherever it is necessary and to study disease 1128 Ch. 12] NON-STOCK CORPORATIONS 1129 for the purpose of discovering means for its prevention. The governmental bodies known as municipal corporations are also non-stock corporations. Not all "not-for-profit" corporations are, however, of the non-stock type. The Mercantile Library of Philadelphia is an example of a stock corporation not organized for profit. The management of non-stock corporations is usually in the hands of a board of trustees or of directors who are elected to serve until the selection of successors. The board of directors in turn elects its officers who are required to look after the imme- diate business of the corporation, very much as in the case of a business organized for profit. 101. Profits Cannot Be Divided To be chartered as a non-stock corporation it is necessary that the organization be, definitely, "not for profit," by which it is meant that any profits earned are not distributable among the members. Many of these corporations conduct businesses or have business connections which result in profits or losses as the case may be. These include publication houses, religious and social magazines, and other business activities of churches, clubs, or other organizations, the profit from which is for the benefit of the membership at large and not for any of the indi- viduals. We have, for example, the Presbyterian Board of Publication, the Baptist Publication Society, and many other like activities. 102. Accounting for Non-Stock Corporations The accounting for non-stock corporations is not different from that of those organized for profit, except that there is no Capital Stock account, nor is there any distribution of dividends. As no stock is issued and no profits are distributed, there is usually no individual interest to be determined. Everything contributed is for the benefit of the institution as such, and should therefore be credited to Capital account, Profits earned 1 130 CORPORATE ACCOUNTING [Bk. Ill- may likewise be credited to Capital account unless it is required that profits be set forth separately, while appropriations for any specific purpose are charged to the same account. There is no objection, however, to crediting profits to a separate account, such as Surplus or Unappropriated Profits, and then making transfers therefrom as needed, either to increase the Capital account or to be used in other ways. 1 a) b'j/ r> w ojj H, 1o 10 aMJainJ io i 103. Entries for a Hospital The example which follows shows certain early transactions of a hospital organized as a non-stock corporation. The Jones Memorial Hospital is established to conduct the usual activities of a general hospital. Thomas Jones has donated for this purpose a large residence in the suburbs of Philadelphia to be converted into a hospital. The appraised value of the property is $100,000, of which $34,000 is the value of the grounds and $66,000 the value of the building. The entry to record this donation will be: Hospital Grounds $34,000 Hospital Building 66,000 To Capital $100,000 Residence and grounds donated by Thomas Jones, for use as a hospital to be known as the Jones Memorial Hospital. Full title has been passed and recorded. 104. Hospital Trust Funds Eleemosynary institutions such as this are frequently made the subject of gifts of money, the principal of which is to be maintained intact, only the income being used. Such funds are capital, but in order to show on the books and financial state- ments the amount reserved from ordinary purposes because of the limitations on the trusts, the credit is usually given to a reserve account instead of to Capital. Such a reserve is an impounding of capital identical in nature with the impounding of surplus. 2 : lie Chf'lII. "Reserve Accounts." Ch. ial NON-STOCK CORPORATIONS 1131 In the present instance, Thomas Jones has given $50,000 to the hospital as a permanent endowment fund, the income thereof to be used for general purposes, and different persons through the influence of Mr. Jones have given $5,000 each for the endow- ment of hospital beds. The entries required in entering these donations are as follows: ij -/ ; $100,000 In exchange for 1,000 shares of the Ellis Cloth Company. Stocks of Other Companies CllOt .'UJ <-.i'.: $100,000 To Unissued Stock : .'|. .~, w ^r^/ ; ti' VL $100,000 In exchange for 500 shares of the Southern Cotton Company. ii od blfjow vitno orfj ,sboJ?. barmbiq lo Jfu/orm. The last four entries might easily be consolidated. It will be seen that the stock has been issued at par and that each lot of stock in other companies has been valued at the par value of the stock given for it. The unsold stock, numbering 3,000 shares, the par value of which is $300,000, will stand as a debit balance of Unissued Stock account until such time as it may be issued. If the stock of the purchasing corporation is of no par value, the rule that no-par stock issued for tangibles is considered as CORPORATE ACCOUNTING [Bk. Ill- being paid for at the value of the tangibles, would apply, s In the above examples of par- value stock, the issuing corporation usually considers its stock worth par. The stock purchased is consequently bought at the par value of the stock issued therefor. When no-par stock is issued for stocks of other corporations, the value of the stocks bought is determined and the following entry made for the value thus determined : Stocks of Other Companies To Capital Stock 115. Bonuses Paid in Stock Stock given as bonuses is issued without any direct con- sideration, and as an extra inducement to purchasers or as a re- ward for faithful services, etc. Such issues are not necessarily improper as they directly benefit trie corporation by promoting the sale of bonds, preferred stock, or other securities. Bonuses given to employees as a reward are usually considered as addi- tional compensation for services, but stock given as a bonus in the sale of bonds or other stock, apparently goes without direct consideration. For this reason such bonuses are usually given out of stock which has once been issued for value and has been donated back to the company. The stock bonuses are charged to a Bonus account at their par value. e Thus, if $10,000 face value of common stock is given from treasury stock as a bonus to the purchasers of a like amount of preferred stock, the entry would be as follows : Bonus $10,000 To Donated Stock $10,000 For 100 shares of donated common stock given as a bonus with 100 shares of preferred stock sold at par. Bonus account may thereafter be treated as part of the organization expenses which, as stated earlier in this chapter, are generally written off over a period of years, or may be closed 'See 5 91, 92. See 77. Ch. 13] MISCELLANEOUS STOCK TRANSACTIONS 1141 into Donated Surplus 7 on the theory that the surplus so accumu- lated has furnished the bonuses. Original stock might be issued as bonus stock so long as no one offers objection, but since, if given purely as a bonus, it would not be full-paid stock, the holders would remain liable to cor- porate creditors for the unpaid value in case of insolvency. In any such case the outgoing stock would be debited to Bonus and credited to Capital Stock or Capital Stock Unissued, as the case may be. In the above statement is found one of the pronounced advantages of no-par-value stock over stock with an established par. The no-par-value stock does not have to be issued for any fixed consideration, or indeed for any determinable consideration whatsoever, and no-par stock of original issue may be used for bonuses without liability on the part of the holders. When such stock is issued as a bonus the only entry needed on the general books is one to record the number of shares so given. This entry would be in the following form: 8 Bonus $ none To Capital Stock $ none For 100 shares of common stock, certificate No , given as a bonus with 100 shares of preferred stock sold at par to .. ' See | 79. ' Cf. | 99. CHAPTER XIV DIVIDENDS' 1 1 6. Ownership of Dividends When a dividend from the net profits of a corporation has once been legally and publicly declared, it cannot thereafter be rescinded or annulled, but its amount is immediately transferred from the corporate ownership to the ownership of the stockhold- ers. This principle holds even though at the time it was declared no definite date was fixed for its payment. Accordingly, divi- dends should be entered on the books of account as soon as they are declared, but even dividends on cumulative preferred stock should not be "accrued" on the books, i.e., shown as a liability before they are declared. 2 117. Dividends Payable Account The Dividends Payable, or simply Dividends account is a liability account whose balance shows the amount of dividends declared but not paid. Its analysis is as follows: DIVIDENDS PAYABLE Debit: With dividends paid, whether by cash or by an issue of stock or otherwise. Credit: With the amount of dividends de- clared by the board of directors, the corresponding debit being made to Sur- plus account or to Undivided Profits account. It is advisable, when crediting this account, to number con- secutively the dividends declared, as "Dividend No. 20," or "Dividend No. 20, payable August i, 1922." A new account 1 SeeBookI.Chs.LII,LIII,"Dividends";alsoBookIII, Chs. XXX, XXXI, "Dividends." 2 See i 126. 1142 Ch. 14] DIVIDENDS 1143 need not be opened each time a dividend is declared, though this is frequently done. If the stockholders are few and the dividend is paid immedi- ately after being declared, it is not necessary to open a Dividend account. 3 1 1 8. Payment of Dividends When a dividend is declared, its amount is credited to Divi- dend account and debited to Surplus. In the smaller corporations dividends are usually paid by check on the general bank account, just as in the case of any other company payment. Cash account is credited and Dividend account debited as the dividend checks are drawn. In the larger corporations it is usual to draw one check pay- able to the bank for the total amount of the dividend, and this check is entered in the cash book and posted to Dividend account in the ledger. This closes the account, and the general books of the company are no longer concerned with that particular divi- dend, no matter how long some of the stockholders may hold their dividend checks before getting them cashed. The check for the total dividend is deposited in the bank to the credit of a special account, as for instance, "Kingston Steel Works Dividends" or "William Kingston, Treasurer," or even in another bank than that in which the corporation keeps its main deposit, and the individual dividend checks are drawn on this account, using a special check book. These are mailed or otherwise delivered to their owners, and from the bank's state- ment of the dividend account it can be seen at any time which stockholders have not, up to that time, drawn their money. This need not concern the general books of the corporation, however, because the entire matter is now outside the usual course of business. The larger corporations with many stockholders usually have specially printed dividend checks, giving the date and number *See i 120. 1 144 CORPORATE ACCOUNTING [Bk. III- of the dividend. By means of an addressing machine, the name and address of the stockholder are stamped on the face of the check in the lower left-hand corner, after which the amount is filled in on the typewriter or other printing machine. After the checks and amounts are verified, proved on the adding machine, and signed by the proper officials, they are placed in window envelopes for mailing. 119. Dividend Sheet or Book The practice of setting aside each quarter or half-year in a separate bank account the exact amount required for the pay- ment of dividends, and drawing special checks against this fund, keeps dividend cash entirely separate from the general cash of the company. A dividend sheet or book 4 should be prepared, showing the names of stockholders, date of dividend, amount and number of each check, etc. As the cnecks are paid a record may be made in this book, if desired, but where the names are numer- ous this is hardly worth while. The dividend sheet or book, as intimated, contains a list of the stockholders entitled to receive dividends. This list is usually made up from the stock ledger each time a dividend is declared, after the transfer books are closed, or if the transfer books are not closed, on the date specified in the resolution declaring the dividend. When the stockholders are many and the stock active, it is very necessary that these lists be compiled, and that care be taken in checking up and proving the amounts which are to be paid. The bound dividend book is used only by small companies whose stock is not active; the larger corporations use loose sheets and place them in binders for convenience. These sheets, if bound together, would constitute the ordinary dividend book. Where stockholders come to the office of the corporation or to the bank for their dividends, a space is allowed on the dividend sheet for their signatures. Some companies prefer this plan as < See Book IV, Forms 257, 258. Ch. 14] DIVIDENDS 1145 it keeps the stockholders in touch with the corporation and its business. Most companies, however, have adopted the plan of mailing dividend checks, and these are always made payable to order. The indorsement of the check is then considered a suffi- cient receipt, and the receipt column is unnecessary. 120. Entries for Cash Dividends To illustrate a simple form of entering cash dividends, suppose the net profits of the Kingston Steel Works for the year 1921 amounted to $38,690.40. The directors have declared dividend No. 7 of 5% on $500,000 of outstanding stock, payable in 10 days. The entries affecting Surplus, the one necessary in closing the books and the other entering the dividend, are as follows: December 31, 1921 Profit and Loss $38,690.40 To Surplus .';}' \ $38,690.40 Closing Profit and Loss account on transactions of 1921. January 7, 1922 Surplus $25,000.00 To Dividend No. 7 $25,000.00 Seventh annual dividend of 5% on the outstanding capital stock of the Company, declared this day by the Board of Directors and payable January 17, 1922. January 17, 1922 Dividend No. 7 $25,000.00 To Cash $25,000.00 For payment of dividend No. 7, as per order of the Directors. In many cases no Dividend account is opened, in which case the dividends paid are charged direct to Surplus account, the entry for the dividend being as follows : January 17, 1922 Surplus $25,000.00 To Cash $25,000.00 Payment of the seventh annual dividend of 5% on the outstanding stock of the Company, declared January 7, 1922, and payable January 17, 1922. 1146 CORPORATE ACCOUNTING |BL HI- If a special bank account is set apart for dividend checks, the transfer of dividend cash is made as explained in 118, by drawing one check for the required amount, Dividend or Surplus account being debited and Cash credited. The individual checks are then issued by the officers in charge of the dividend disbursements. abnabiviQ ilasO io\ asrrtnS .osi $ 121. Dividends on No-Par Stock Dividends declared on stock of no par value cannot be, of course, in terms of any per cent per share, but must be a specified amount of money per share. There is no other difference be- tween dividends on par- value and on no-par stock than this: that the dividend is declared at so much per share, and not so much per cent. Holders of no-par stock share equally in dividends and have proportionate interests in capital and profits regardless of the prices paid for their shares. The book entries of the dividends are the same for either kind of stock. 122. Dividends Paid with Borrowed Money It is not unusual for even the most prosperous company to be temporarily short of ready cash to meet dividend payments. The current assets may be three times as much as the current liabilities, and yet consist largely of notes and accounts receiv- able which cannot be used to pay dividends. In such a case it is perfectly proper for the directors to borrow money to pay a dividend. In that event the following entries might be made, the first a journal entry, all the others cash book entries: January 4, 1922 Surplus $10,000 To Dividends Payable $10,000 Dividend of 5% declared this day on capital stock of the Company. Payable in cash January 15, 1922. January 13, 1922 Cash $10,000 To Notes Payable $10,000 Three months' note discounted at First National Bank to secure funds for payment of dividend due January 15. Ch. i4] DIVIDENDS 1147 Discount $150 To Cash $150 Discount at 6% on Company's three months' note of $10,000. January 15, 1922 Dividends Payable $10,000 To Cash $10,000 Payment of dividend of 5% on capital stock of the Company. 123. Entries for Scrip Dividend Another way to pay a dividend when temporarily short of cash is by an issue of scrip. Scrip is a promissory note of a corporation, usually bearing interest, and falling due upon a specified date, or after a specified occurrence, as for instance when a proposed bond issue shall have been sold. The scrip is in the form of certificates, on which appear the company's promise to pay the money and the various terms of the contract. These certificates sometimes call for or are convertible into stock of the company, and such scrip sometimes participates in divi- dends. The scrip certificates are frequently transferable, and pass by assignment from hand to hand in the open market. The Novelty Manufacturing Company with a capital stock of $1,500,000, $1,000,000 being common stock and $500,000 pre- ferred stock, declares its regular annual dividend of 3% on both issues, payable in scrip. Dividend declared May 15, 1921, payable June 15, 1921; scrip, payable in cash June 15, 1922, and bearing interest at the rate of 5%. The journal entries for the declaration and payment of this annual 3% scrip dividend on the common and preferred stock are as follows: May 15, 1921 Surplus $45,000 To Dividend Common $30,000 Dividend Preferred 15,000 Annual dividend of 3% on both common and preferred stock declared this day, payable June 15, 1921, in scrip of the Company, maturing June 15, 1922, and bearing interest at 5%. 1148 CORPORATE ACCOUNTING [Bk. Ill- June 15, 1921 Dividend Common $30,000 Dividend Preferred 15.000 To Dividend Scrip (or Scrip Payable) $45,000 Dividends paid this day in scrip maturing June 15, 1922, and bearing interest at 5%. When the scrip matures, an entry similar to the following is necessary: . June 15, 1922 Dividend Scrip $45,000 Interest 2,250 To Cash $47,250 For payment of dividend scrip maturing today, with interest from June 15, 1921, at 5%. 124. Entries for Special and Interim Dividends Occasionally, after a very prosperous year or a longer period of prosperity, during which a large surplus has been accumu- lated, the directors declare a "special dividend" or "bonus" in addition to the regular dividend. This is commonly called "cutting a melon." Sometimes the employees of the company also participate, and this is known as "profit-sharing." To illustrate the entry of such dividends, assume that a corporation with $1,000,000 capital stock, and profits for the year of $125,400, declares its regular annual dividend of 7% and at the same time declares a "special dividend" of 2%, and awards to its employees a bonus of 10% of the net earnings of the year just ended. The entries are as follows: January 4, 1922 Surplus $102,540 To Dividend No. 17 $70,000 Special Dividend No. i 20,000 Bonus to Employees 12,540 As per resolution passed this day by the Board of Directors declaring the regular annual dividend of 7% on the capital stock of the Company; an additional dividend of 2%; and awarding to the employees a bonus of 10% of the net earnings of the year just ended; all payable in cash on the i5th day of January, 1922. Ch. 14] DIVIDENDS 1149 January 15, 1922 Dividend No. 17 $70,000 Special Dividend No. i 20,000 Bonus to Employees 12,540 To Cash $102,540 For payment of dividends and bonus provided for in resolution of the Board of Directors passed January 4. Dividends declared between the regular dividend dates are called "interim dividends," and are declared when unusual profits exist to justify a special dividend, or when for some reason it is desired to anticipate the regular dividend in whole or in part. When dividends are paid quarterly, as is the case with most of the larger corporations, an interim dividend is seldom declared. The entries in case of interim dividends would of course be exactly the same as the entries required for any regular dividend. 125. Entries for Dividends Applied to Stock Subscriptions 5 As a declared dividend is a debt due from the corporation to the stockholder, any indebtedness o'f a stockholder to the cor- poration may be set off against his dividend and be deducted from it, provided the debt is actually due at the time the dividend is payable. To illustrate the entries when dividends are to be applied on a stock subscription, let us suppose that $200,000 par value of new stock of the Kanawha Iron Works (shares $50 each) has been offered for sale to provide funds for the erection of additional buildings; that all this has been subscribed, and a first instal- ment of 50% has been paid upon it. John Smith is a subscriber for 10 shares. On January 5, 1922, the board of directors passes a resolution calling for the final instalment of 50% on the entire subscribed stock, payable February i. On February 3, at which time John Smith has not paid the final instalment on his stock, the directors declare an annual dividend of 5% on the entire * See Book I, | 485. 1 1 SO CORPORATE ACCOUNTING [Bk. III- outstanding stock ($500,000) as of January i, payable February 15. The entries for these transactions are as follows: First Entry: January 5, 1922 Final Instalment on Stock (or Instalment No. 2) $100,000 To Subscriptions $100,000 As per resolution passed this day by the Board of Direc- tors, calling for the final instalment of $100,000 on $200,000 of capital stock of the Company. This entry will close the Subscriptions account, substituting for it the Final Instalment account. Assuming that all the stock- holders have paid the first instalment in full, the First Instalment account is already closed. Second Entry: February i, 1922 Cash $99i75 To Final Instalment on Stock $99,750 Payment of final instalment on capital stock. This, of course, would be comprised in cash book entries showing the names of the stockholders and amount paid by each. To simplify the illustration, it is assumed that all except John Smith had paid at the time of declaring the dividend. Third Entry: February 3, 1922 Surplus $25,000 To Dividend No. 5 $25,000 The Board of Directors have this day declared the regular annual dividend of 5% on the capital stock of the Com- pany, payable in cash on the i5th day of February. Fourth Entry: February 15, 1922 Dividend No. 5 $24,975 To Cash $24,975 Dividend paid this day as per resolution of the Board of Directors, February 3. Ch. 14] DIVIDENDS 1151 Fifth Entry: February 15, 1922 Dividend No. 5 $25 To Final Instalment on Stock $25 To apply dividend of John Smith as part payment of final instalment of $250 due on 10 shares of capital stock of the Company. 126. Cumulative Dividends Passed Although preferred stock dividends may be payable before the common stock can receive any share of the profits of the cor- poration, these dividends do not become an obligation of the company until they are formally declared by the board of direc- tors. It is therefore improper to enter "passed" dividends on the books as an obligation at the time, although this is sometimes done. Nor should they appear among the liabilities on the balance sheet, though it is necessary to show by means of a foot- note the contingent liability for the dividends which have been "passed." Where a preferred dividend is passed but it is desired that it be shown on the books, it might be done by an entry similar to the following: Surplus $30,000 To Unpaid Preferred Dividend $30,000 For 192 1 preferred dividend of 6% not declared by the Board of Directors but ordered to be shown upon the books. This might make the Surplus account show a debit balance, and in any event it would be reducing surplus for the sake of a liability which was only contingent and which, since the dividend had not been declared, would not hold as against outside creditors. 127. Entries for Stock Dividends Sometimes the directors declare instead of a cash dividend, what is known as a "stock dividend." There may be stock in the company's treasury, donated or purchased, that may properly 1 152 CORPORATE ACCOUNTING [Bk. Ill- be divided among the stockholders in the form of a dividend. Or unissued stock may be issued for the purpose, or new stock may even be created. The directors are perfectly justified in using such stock for dividends, provided there are undivided profits of an amount equal to the face value of the stock issued as dividends. To illustrate the entries, suppose that the Michi- gan Furniture Company, with an authorized capital stock of $1,000,000, has had a very prosperous year, its profits amounting to over $100,000, but the directors desire to invest most of their available funds in additional shops and machinery. Their regu- lar annual dividend is 10%. Only one-half of the authorized capital stock has been issued, so they declare the regular 10% dividend but make it payable in stock of the company. Surplus $50,000 To Dividend No. 4 $50,000 A dividend of 10% on the $500,000 outstanding capital stock of the Company has this day been declared by the Directors, payable in stock of the Company. Dividend No. 4 $50,000 To Capital Stock $50,000 Stock issued to pay stock dividend of 10%. If the unissued stock is being carried on the books in Unissued Stock account, the second entry would be a credit to that ac- count. If the dividend were paid out of treasury stock, Treasury Stock account would of course be credited. 128. Dividends Payable in No- Par Stock When a stock dividend is payable in stock without par value, the only entry required on the general books is one indicating the number of shares thus disposed of. 6 No value, not even an arbitrary one, is being disposed of, the stockholders' proportion- ate interest remains the same, but is merely cut up into more pieces by having more shares outstanding. The amount of sur- c/. jus. Ch. 14] DIVIDENDS 1153 plus available for other dividends, whether stock or cash, is not affected in the least. If in the case presented in the previous section the stock of the Michigan Furniture Company was of no par value, the entries on the journal would be as follows: Surplus $ none To Dividend No. 4 $ none A dividend of 10% on the outstanding capital stock has this day been declared by the Board of Directors, said dividend being payable in the capital stock of the company. Dividend No. 4 $ none To Capital Stock $ none .... shares of stock issued to pay stock dividend of 10%. 129. Dividends Paid in Bonds or Property If there are profits from which dividends may be legally paid, the directors may pay them in any property 7 owned by the cor- poration as well as in cash or stock, or they may pay them in bonds of the corporation as well as in short notes (scrip). The only stipulation is that they shall be issued against actual profits. If in the preceding example the directors, with the consent of the stockholders, had paid the dividends in bonds, the entries would be as follows: Surplus $50,000 To Dividend No. 4 $50,000 A dividend of 10% on the capital stock of the Company has this day been declared by the Directors, payable in the first mortgage bonds of the Company. Dividend No. 4 $50,000 To First Mortgage Bonds $50,000 First mortgage 4% bonds given to stockholders in payment of 10% dividend on the stock of the corporation. If the dividend had been paid in property of the corporation, such as merchandise produced by it, the credit would have been passed to the proper asset account instead of to First Mortgage Bonds. 7 See Book I, | 493. 1154 CORPORATE ACCOUNTING [Bk. III- 130. Bank Dividends Banks pay dividends on their stock with checks drawn on themselves (cashiers' checks), and this makes the bookkeeping entries slightly different from those of other companies. The first entry is: Undivided Profits $50,000 To Dividend No. 34 $50,000 For dividend of 5% declared this day by the Directors on the capital stock of the bank. The charges to Dividend account come from the cash book as the dividend checks are presented for payment at the paying teller's window or through the clearing house. The balance of Dividend account, therefore, shows the amount of dividend checks outstanding, and appears on the balance sheet as "Unpaid Dividends." 131. Unearned Dividends 8 Although the laws of all of the states forbid the payment of dividends if such payment results in the impairment of capital, there are more or less frequent evasions of this rule. The fact that a dividend has been paid out of capital may not be known to anyone except the directors; in fact, the directors themselves are sometimes ignorant of such an occurrence, owing to errors as to profits or due perhaps to the fact that they will not take the trouble, or have not sufficient knowledge of accounting, to inform themselves of the true condition of the company. Yet they may be held liable by the courts for any loss to creditors occasioned by the payment of dividends out of capital. Errors as to profits may arise from many causes. The books of the company may perhaps show a surplus of earnings which in reality does not exist, because no provision has been made for bad debts or depreciation; or materials have been included in the Inventories which have not yet been credited to Accounts Payable; or materials have been valued at the selling price; or See Book I, } 498. Ch. 14] DIVIDENDS 1155 orders for future delivery may have been booked as sales; the book value of real estate may have been written up; assets with no value, such as patents and copyrights which have expired, may still be carried upon the books; judgments against the company may have been omitted from the accounts. These and other errors may have been made which hide the fictitious char- acter of the apparent profits, so that the payment of dividends under such conditions results hi an impairment of capital. An examination by a competent auditor, however, would disclose any such errors and prevent the declaration of illegal dividends. In case accounting errors are discovered which have resulted in a fictitious surplus, the proper charges must be made to show the true condition. This may, if dividends have been declared or other expenditures have been made on the strength of the supposed surplus, result in a debit balance in Surplus account. It is perfectly proper to allow this debit balance to remain on the ledger until wiped out by the accumulating profits, but in the balance sheet it should be placed on the asset side and called "Deficit," or be shown on the liability side as a deduction from the capital stock. 132. Income from Dividends A corporation owning stock in another company will ordin- arily have income in the form of dividends paid by the under- lying corporation. Were a 6% dividend declared by the Baldwin Mercantile Company, in which we have an investment to the extent of $260,000 par value, an entry similar to the following would be required on our books upon receipt of the money Cash $15,600 To Dividends on Investments $15,600 For dividend of 6% on $260,000 par of stock of the Baldwin Mercantile Company. Dividends on Investments account would close into Profit and Loss at the end of the fiscal period. CHAPTER XV TYPICAL CORPORATE ORGANIZATIONS ""' 133. Organization Procedure The organization details outlined in this and the following chapters are in accordance with the laws of the states in which the corporations are respectively incorporated. Of course, an attorney will be retained when an incorporation is to be made, and on him rests the direct responsibility for the technical details; but the accountant should have at least a sufficient knowledge of the required procedure to make his record intelli- gent. A MANUFACTURING CORPORATION 134. Details of Incorporation The preliminary organization of the Rockwell Manufactur- ing Company, of Philadelphia, was effected on March 2, 1922. The company was incorporated for the manufacture and sale of household furniture, with a capital stock of $100,000, con- sisting of 1,000 shares of the par value of $100 each. The in- corporators and the number of shares subscribed for by each are as follows: Name Address Shares Amount George Rockwell 657 Broad St., Philadelphia 400 $40,000 Jane Rockwell 657 Broad St., Philadelphia 200 20,000 Henry Lindon 1415 Market St., Philadelphia 300 30,000 Thomas J. Peterson Harrisburg, Pa. 100 10,000 The first instalment of 10%, as required by the Pennsylvania law, has been paid in cash. Immediately after the date of final organization, another payment of 50% will be due, and the balance will be payable one month thereafter, 1156 Ch. 15] TYPICAL CORPORATE ORGANIZATIONS 1157 135. Books of Account After the organization has been completed and all require- ments complied with, it is in order to make the necessary records in the books of the corporation. The particular books of account to be used are not prescribed by statute, except that either the treasurer or secretary is required to keep at the office of the principal place of business a book containing the names of all persons who are, or who within one year shall have been, stock- holders of such company, showing the number of shares held, when they became owners thereof, the amount paid in, etc. 1 Regardless of the absence of specific stipulations in the law, a complete set of accounting books should be provided, and they must of course be properly kept. The opening entries for jour- nal and cash book are shown on the following pages, including payment of the first and second subscription instalments and the customary expenses at the time of incorporation. Accounts with stockholders must be opened in the stock ledger, instal- ment receipts issued, and the stock certificate book made ready for use as soon as the instalments are completed. 2 136. Journal Entries For opening entries, the plan that will best suit the case of the particular corporation should be adopted. Since there are only a few subscribers to stock, separate subscription and instal- ment registers are not necessary, as their names can be entered in the subscription and instalment accounts. It will be noted that the first cash was received March 2, 1922, the date of application for charter. Since, however, the corporation does not come into legal existence until the charter is granted, it would seem desirable to make the opening entries on March 23, the actual date of organization. Entries should state all details fully, however, and give the dates of any pay- ments already made. 'The stock ledger shown in Book IV, Ch. VII, "Stock Books," will satisfy the require- ments of Pennsylvania and of most other states. * See Book IV, Ch. V, "Subscription Receipts and Records," also Ch. VI, "Stock Certifi- cates." 1158 CORPORATE ACCOUNTING [Bk. HI- Because all the capital stock is subscribed at the outset and is to be paid for within a short period, a single Capital Stock account is used instead of the Capital Stock Authorized and Capital Stock Unissued accounts. 3 First Entry: March 23, 1922 Subscriptions $100,000 To Capital Stock $100,000 Incorporation of the Rockwell Manufacturing Company with a capital stock of $100,000, shares $100. Sub- scriptions as below (under date of March 2, 1922) on terms of 10% down, 50% on date of organization, and the balance in one month: George Rockwell 400 shares Jane Rockwell 200 " Henry Lindon 300 " Thomas J. Peterson 100 " The first instalment of 10% having been paid at the time of incorporation, is entered directly in the cash book, as shown on the next page. Next, under the same date, an entry is made for the second instalment. The first instalment might of course be put through the journal as is the second, but, as it has already been paid, the cash book entry would seem to be all that is necessary. We might also omit the entry for Instalment No. 2 and let that likewise be credited to Subscriptions through the cash book. Second Entry: March 23, 1922 Instalment No. 2 $50,000 . To Subscriptions , ~ $50,000 For second instalment, being 50% of the amount sub- scribed: George Rockwell $20,000 Jane Rockwell 10,000 Henry Lindon 15,000 Thomas J. Peterson 5,ooo If an instalment register 4 is used, the journal entries for See { 36. See 58. Ch. 15] TYPICAL CORPORATE ORGANIZATIONS "59 instalments would usually be omitted, and payments credited directly to Subscriptions account through the cash book. When Instalment No. 3 becomes due in one month, it will be treated in the same manner as Instalment No. 2. Stock certificates should not be issued. until the final instal- ment is paid, and upon their issuance it would in most states be necessary to open accounts with the individual stockholders in a stock ledger. 137. Cash Book Entries CASH BOOK Receipts 1922 Mar. 23 Subscriptions 10% paid in, by: George Rockwell . . . $4,000.00 Jane Rockwell 2,000.00 Henry Lindon 3,000.00 Thomas J. Peterson . 1,000.00 Instalment No. 2, 50%: George Rockwell. . . 20,000.00 f i;i Jane Rockwell 10,000.00 Henry Lindon 15,000.00 Thomas J. Peterson . 5,000.00 1922 Mar. Payments 23 Incorporation Expen- ses: Charter Fee $ 30.00 Bonus on Capital. . . . 200.00 Recording Fees 2.50 Counsel 100.00 Accountant 100.00 Equipment 100.00 Expenses. 35.00 138. The Ledger Accounts CAPITAL STOCK 1922 Mar. 23 Subscriptions $100,000 SUBSCRIPTIONS 1922 Mar. 23 Capital Stock: George Rockwell. . . . $40,000 Jane Rockwell 20,000 Henry Lindon 30,000 Thomas J. Peterson.. 10,000 1922 Mar. 23 Cash, 10% $10,000 Instalment No. 2, 50% 50,000 n6o CORPORATE ACCOUNTING INSTALMENT No. 2 50% [Bk. III- 1922 Mar. 23 Subscriptions, 50%: George Rockwell . . $20,000.00 Jane Rockwell. . .'. 10,000.00 Henry Lindon. . . . 15,000.00 Thomas J. Peterson 5,000.00 3,000.00 1922 Mar. 23 Cash $50,000.00 (Payment may be credited separ- ately if desired.) 50,000.00 INSTALMENT No. '3 40% (Same form of account as for Instalment No. 2) A MINING CORPORATION 139. Details of Incorporation To illustrate the opening entries for a mining company, assume that the Copper County Mining Company is to be incorporated under the laws of Michigan with an authorized capital stock of $50,000, consisting of 2,000 shares of $25 each. The company is to take over from James R. Cooke and Frank Patterson, a partially developed copper mine located in Copper County, Michigan, and carrying with it 200 acres of mineral' land. The incorporators and the amount of stock subscribed for by each as of April 3, 1922, are as follows: Name Address Shares James R. Cooke Detroit, Michigan Frank Patterson Calumet, " John H. Jerome Detroit, John H. Wilson The entire mine property is conveyed to the company by Cooke and Patterson in full payment for their subscriptions, and Jerome pays cash in full for his 100 shares. Wilson pays $100, but, failing to pay the balance, his stock is declared forfeited. Cooke and Patterson each donate 200 shares of stock to the com- pany, this stock to be sold for the purpose of providing working capital. Of the donated stock, 200 shares are sold at $15 per 900 900 100 IOO Amount $22,500 22,500 2,500 2,500 Ch. 15] TYPICAL CORPORATE ORGANIZATIONS 1161 share and 100 shares at $20 a share. All this stock is paid for in cash. The sum of $2,000 has been paid out for development expenses, and $1,000 is paid on account of new buildings and construction. The various organization expenses have been paid by the incorporates, who are reimbursed after incorpora- tion. 140. Opening Entries The books of account must contain a complete record of the business operations of the company. The official books and records to be kept by the secretary must be purchased and duly entered up. Opening entries for the corporation are made, under a slightly different plan from the preceding illustrations, as on April 3, 1922, the date of organization: April 3, 1922 Unissued Stock $50,000 To Capital Stock Authorized $50,000 The Copper County Mining Company has this day been in- corporated with a capital stock of $50,000, par value of shares $25 each. (See minute book, page 4.) James R. Cooke $22,500 Frank Patterson 22,500 John H. Jerome 2,500 John H. Wilson 2,500 To Capital Stock Subscribed $50,000 Subscriptions have been received as follows: James R. Cooke 900 shares Frank Patterson 900 " John H. Jerome 100 " John H. Wilson 100 " Cash $ 2,600 To John H. Jerome $ 2,500 John H. Wilson 100 For full payment of Jerome's subscription to 100 shares of stock, as per agreement; payment of $100 on Wilson's stock, balance to be paid in 10 days. n62 CORPORATE ACCOUNTING [Bk. Ill- Copper County Mine Property $45,000 To James R. Cooke mi $22,500 Frank Patterson 22,500 The Copper County Mine property and all improvements have this day been conveyed to the Company by Cooke and Patterson in full payment for their subscriptions to stock of the Company, 1,800 shares. By order of the Directors. (See minute book, page 5.) Capital Stock Subscribed $47,500 To Unissued Stock .....? $47,500 To record the issuance of certificates, as follows: John H. Jerome (No. i) too shares James R. Cooke (No. 2) 900 " Frank Patterson (No. 3) 900 " Organization Expenses $ 325 To Cash .'/.'/. ..l ]i . J . .# $ 325 To cover various incorporating fees and expenses advanced by incorporators, $35; charges of attorney, $150; charges of accountant, $75; other preliminary expenses, $65. 141. Entries for Donated Stock When stock is donated to the treasury of a company, an entry is required debiting Donated Stock or Treasury Stock, 5 and crediting Working Capital Donated, Donation, or Donated Surplus account, as follows: Treasury Stock $10,000 To Working Capital Donated $10,000 For 400 shares of the Company's stock donated by James R. Cooke and Frank Patterson, 200 shares each, to be sold to provide working capital. The donated stock is placed in the hands of a trustee, usually one of the officers, appointed either by the donors or by the company. An account with this trustee is opened in the stock book and credited with the 400 shares donated. The stock book accounts of the donors are of course debited. The donated certificates are attached to their respective stubs in the stock certificate book and canceled, but stock certificates need not be * See Ch. X, "Par- Value. Donated Stock." Ch. 15] TYPICAL CORPORATE ORGANIZATIONS 1163 made out in the trustee's favor, as that necessitates the making of transfers each time a sale is made. As the stock is sold certificates are made out direct to the purchasers, but the record of issue, both in the stock certificate book and in the stock ledger, will show that the stock has been transferred from "Trustee" account. The following entries, most of them in the cash book, are necessary: Cash $3,000 Working Capital Donated 2,000 To Treasury Stock $5,000 For sale of 200 shares of treasury stock at $15 per share to the following persons: (Names entered here) Cash $2,000 Working Capital Donated 500 To Treasury Stock ,..'... $2,500 For sale of 100 shares of treasury stock at $20 per share to the following persons: (Names here) Cost Of Development $2,000 To Cash $2,000 Expenditures for developing the surface and entrance to the mine. Mine Construction (or Building and Improvements) $1,000 To Cash $1,000 Expenditures for construction purposes at the mine. 142. Entries for Forfeited Subscription The subscription of John H. Wilson was not completed, and after calling on Wilson for payment of the amount still due on his stock, $2,400, without result, it was declared forfeited. It is debited back to Capital Stock Subscribed as follows: Capital Stock Subscribed $2,500 To John H. Wilson $2,400 Profit on Forfeited Stock 100 For 100 shares of stock subscribed for by John H. Wilson, on which but $100 was paid and the stock was therefore de- clared forfeited. 1 1 64 CORPORATE ACCOUNTING [Bk. III- The entry to be made for forfeited stock must obviously depend on the manner of making the opening entries. The $100 paid by Wilson is retained by the corporation and is credited to Profit on Forfeited Stock, to Premium, or directly to Paid-in Surplus. 6 Before forfeiting stock for unpaid sub- scriptions, the statutes of the state should be consulted for the procedure required. In the absence of any such provision, the stock may be forfeited when the subscriber, after demand there- for, refuses or fails to pay the amount due. Sometimes the for- feited shares are advertised for sale and sold to the highest bidder who in this ease must offer at least $2,400. There are still on hand 100 shares of treasury stock which may be sold at an early date or held until it will sell for a higher rate or even a premium. In case the mine proves to be success- ful, there should be no difficulty in disposing of this stock at a higher price. The profit realized from the donation of stock may be transferred from Working Capital Donated account to Surplus, if so desired. The foregoing entries are for a mine with a small capitaliza- tion,but the general requirements are the same for any mining company. CHAPTER XVI INCORPORATION OF SOLE PROPRIETORSHIP 143. Financial Details of the Incorporation Charles W. Hampton has been conducting a wholesale and retail mercantile business for the past ten years in the City of New York. He wishes to bring other parties into the business, and with this in view has decided to incorporate as of May 9, 1922, under the name of the "Hampton Trading Corporation," with a capital stock of $250,000, consisting of 2,500 shares of the par value of $100 each. The balance sheet of Charles W. Hampton is as follows: CHARLES W. HAMPTON BALANCE SHEET, AS OF MAY i, 1922 Assets Liabilities Land . $ 30,000 Mortgage on Warehouse $ 25,000 Store and Warehouse ; ' ' 50,000 Loans from Bank. ....... ^ 10,000 Store Equipment S,< oo Notes Payable 17,750 Delivery Equipment o.ooo Accounts Payable . . 22,800 Merchandise . . .' '. '. '.' . 46,300 Total Liabilities . . .' . \ $ 7C, 5 o Accounts Receivable. . . . .j'<; / 16,400 Charles W. Hampton, Capital Notes Receivable O.7CO Account 105,140 ( ,'ash ....... 6,740 $180,690 $180,690 'n(-ft rn 2'vdnr, The shares have been subscribed for as follows: Name Address Shares Amount Charles W. Hampton New York City 1,250 $125,000 Samuel Johnson " Soo 50,000 James J. Miller 500 50,000 Lincoln Webster Albany, New York 100 10,000 Robert W. Kester too 10,000 Il66 CORPORATE ACCOUNTING [Bk. III- Hampton is to receive 1,250 shares of full-paid stock in exchange for his business, buildings, stock, and equipment, including the various assets and liabilities as per the accompany- ing balance sheet. The business of Hampton is to be taken over as soon as possible after the first meeting of the directors, at which time the other subscribers to the stock of the company will pay 50% of their subscriptions, the remainder to be paid August 9, 1922. 144. Good-Will i The net worth of this business, which the corporation is to purchase for $125,000 of its capital stock, is seen by the above balance sheet to be $105,140. If this is the real value of these net assets, and the capital stock is considered as being worth its face value, then there must be another asset of a value of $19,860 which is being purchased. This asset is the good-will of Charles W. Hampton, the proprietor of the individually owned business. Good-will is not an item entering solely into corporation practice, therefore a full consideration of it would be beyond the purposes of this work. It does, however, enter into transfers of going businesses with such uniformity that it cannot be altogether ignored. "Good-will is the monetary value placed upon the connection and reputation of a mercantile or manufacturing concern, and discounts the value of the turnover of a business in consequence of the probabilities of the old customers continuing." 2 An eminent English jurist 3 defines good-will as "every advantage . , . that has been acquired by the old firm in carrying on its business, whether connected with the premises in which the business was previously carried on, or with the name of the late firm, or with any matter carrying with it the benefit of the business." 1 See also Book I, 5 91; and Book II, 5 127-132. 2 Lisle on Accounting in Theory and Practice. 3 Vice-Chancellor, Sir W. Page Wood. Ch. 16] INCORPORATION SOLE PROPRIETORSHIP 1167 Lisle in his "Accounting in Theory and Practice," gives as the basis of the value of good-will, the place, the name, and the chance that no one connected with the old firm will step in to compete. There are other elements which enter in, however; such as the personnel of the concern, its trade-marks, etc. Al- though complex, good-will may be denned in general terms as the value of any benefits a business may enjoy or advantages it may possess, apart from its actual property or other tangible holdings. 145. Practical Aspects of Good- Will In another part of the present volume an accepted method of determining the value of good- will has been given. 4 The purchase and sale of a going business, however, is a matter of barter, and barter is a problem of give-and-take. The price agreed upon between a buyer and a seller may not be, in the opinion of ex- perts, the value of the article. Usually it is based on a compro- mise between the buyer and seller rather than upon any theoreti- cal or appraised valuation. The purchase price of the good-will, therefore, becomes the difference between the amount paid for the other assets and the total amount paid, irrespective of any calculation as to what its value should be. It is, then, the difference between the actual value of the property for which stock of a corporation is issued and the par value of that stock. Good-will is a thing to be acquired, arid not created arbi- trarily by a book entry, and if it is legitimately acquired for value there is no reason why it should not be allowed to remain on the books as a permanent asset. But because of the wide- spread practice of overcapitalizing which has grown up in cor- porate organizations, the Good- Will account is almost invariably the difference between the true value of the tangible assets taken over and the value acquiesced in or placed upon the business as a whole by the board of directors. In other words, a Good- Will account is commonly used in the books as an offset to overcapi- talization of the tangible assets. Book II, Ch. XIII, "Capitalization Good- Will, Surplus and Initial Expense," Il68 CORPORATE ACCOUNTING [Bk. 111- 146. Accounting Treatment of Good-Will Because of this fact, good-will is looked at with suspicion, and there has been a tendency in modern business to dispense with good-will altogether, it being written off the books grad- ually. The General Electric Company and the Victor Talking Machine Company have each written their good-will down, the one to $i and the other to $2. at which amounts it is now being carried on their respective books; and many other prominent corporations have pursued the same policy. The tax laws enacted during the period of the Great War checked this trend; but now that invested capital no longer enters into federal in- come tax computations, we may see a return to the former practice of writing down good- will, even when it has been pur- chased for cash, by charges against Profit and Loss or Surplus. If the good-will is on the books because of an excessive over- capitalization, it may well be written down as a surplus is acquired. The analysis of the Good- Will account is then : GOOD-WILL Debit: With the cost of good-will acquired . Credit: With any portion of .good-will sub- sequently written off. ;><\'j JOI 147. Opening Entry We may assume that the business of Hampton has been taken over in payment for stock, the first instalment on stock subscrip- tions has been received, and the various organization expenses have been paid. It is now necessary to complete the official records and make the opening entries in the books of account. The opening entries in the books of account should now be made, according to the plan adopted by the accountant. A matter of prime importance here is the inclusion of adequate and complete explanations. Vague or incomplete records should not be tolerated. Ch. 16] INCORPORATION SOLE PROPRIETORSHIP 1169 In the opening entries which follow, the accounts of incor- porators are entered in the general ledger. This would not be advisable if the number of incorporators or subscribers to be en- tered were large. 5 May 9, 1922 Charles W. Hampton $125,000 Samuel Johnson 50,000 James J. Miller 50,000 Lincoln Webster 10,000 Robert W. Kester 10,000 Unissued Stock 5,000 To Capital Stock $250,000 Hampton Trading Corporation, incorporated with an authorized capital of $250,000, divided into 2,500 shares of $100 each, subscribed for as follows: Charles W. Hampton 1,250 shares Samuel Johnson 500 " James J. Miller 500 " Lincoln Webster 100 " Robert W. Kester 100 ,)?%,! % Unissued Stock 50 " Subscriptions payable 50% in cash and balance August 9, 1922. 148. Transfer of Business At the time of incorporation, certain necessary expenses must be advanced by the incorporators or by the attorney in charge. These are reimbursed after organization. All cash entries are given in the cash book shown below. The only remaining journal entry required is that recording the transfer of assets and liabili- ties from Hampton to the corporation. As will be seen, the cash turned over by Hampton is included in the journal entry, in order to show all of the assets and liabili- ties together. This plan, which obviates the necessity of splitting entries, is to be favored for it sets forth the entire transaction. The cash account is ticked in the journal, and the general ledger account in the cash book, to indicate that they are not to be ' For other entries to accomplish this result, see Ch. VI, "Par- Value Stock of Original Issue Not Full-Paid at Once." 1170 CORPORATE ACCOUNTING [Bk. Ill- posted. If this were not done, the items might be posted from both books. Land $30,000 Store and Warehouse 56,000 Store Equipment 8,500 Delivery Equipment 9,000 Office Equipment 4,400 Merchandise 46,300 Accounts Receivable 16,400 Notes Receivable 9.35Q Cash , 6,740 Good-Will 19,860 To Mortgages Payable $ 25,000 Bank Loans , 10,000 Notes Payable i775O Accounts Payable 22,800 Charles W. Hampton 125,000 For the entire assets and liabilities of Charles W. Hampton, taken over this day in full payment of his subscription. A good-will of $19,860 is allowed over and above the net worth indicated by his balance sheet. (See minutes of stockholders and of directors for authority and for further details.) 149. Cash Book Entries CASH BOOK 1922 May 9 Samuel Johnson (Paid on May 2) $ 500 Charles W. Hampton (Balance transferred) 6,740 Samuel Johnson 24,500 James J. Miller 25,000 Lincoln Webster 5,000 Robert W. Kester. ... 5,000 (Payment of first in- stalment of 50% on subscriptions to stock.) $66,740 1922 May 9 Organizing Expenses: Organization Tax $ 125 Filing Certificate 10 Recording Fees 20 Counsel's Fee 250 Accountant's Fee 250 Other Outlays 200 Balance 65,885 $66,740 Ch. 16] INCORPORATION SOLE PROPRIETORSHIP 1171 150. Other Entries The necessary entries have now been made in the journal and cash book, and the accounts called for by these entries must be opened in the general ledger. An account should also be opened for unissued stock. The subscribers' accounts will be credited and cash debited, through the cash book, when the final pay- ments are made August 9, 1922. There is nothing unusual in the form of any of these ledger accounts and they are not shown here in account form. In the stock ledger, records of the stockholdings of each sub- scriber must appear. Instalment receipts must be issued as pay- ments are received, and stock certificates made out when the final payments are made. It is the duty of both the attorney and accountant to see that the general procedure is in accordance with legal and business requirements. CHAPTER XVII INCORPORATION OF PARTNERSHIP 151. Conditions of the Incorporation The entries of the present chapter are those required for the amalgamation and incorporation of two Chicago partnerships which for a number of years have been successfully engaged in manufacturing. The entire business plant, good-will, current assets, and liabilities of each concern is to be transferred to the new company in exchange for capital stock. In Illinois the entire capital stock must be subscribed and one-half paid up before the company is permitted to begin opera- tions, and therefore the partnership agreements to take stock appear in the application for a charter. The actual transfer of the partnership assets and liabilities to the corporation is not, of course, made until the latter is completely organized and ready to enter into contracts. The transfer acts practically as a dis- solution of the partnerships. The change of ownership incident to the transfer of a partner- ship business to a corporation does not necessarily produce any change in the business or in the established policy of manage- ment; or even in the manner of keeping the books of account, except such changes as are necessary to adjust the capital ac- count to the altered conditions. During the process of the incor- poration now to be considered, the partnerships go on with their operations as before, all profits after the agreed date belonging to the corporation. 152. Agreement for Incorporation Certain preliminary agreements have been entered into by the owners of the two concerns now being consolidated. The 1172 Ch. 17] INCORPORATION OF PARTNERSHIP 1173 details necessary for the accountant's purpose are given in the following extracts from the preliminary agreement for incor- poration : This Agreement for Incorporation made this 2 8th day of April, 1 92 2, by and between Robert Lowell, Walter F. Mason, and Norman Lowell, copartners in the manufacture and sale of chemicals and chemical supplies in the city of Chicago, under the firm name of Lowell, Mason & Company, and Nelson G. Oliver and George Dickson, copartners in the manufacture of chemicals, also in the city of Chicago, under the firm name of Oliver & Dickson. Witnesseth: 1. That the business heretofore conducted by each of the above- named firms shall be amalgamated and incorporated under the laws of the State of Illinois as the Lowell-Mason Chemical Company. 2. That the capital stock of said corporation shall be Five Million Dollars ($5,000,000), consisting of Three Million Dollars ($3,000,000) of common stock, being 30,000 shares of the par value of One Hundred Dollars ($100) each, and Two Million Dollars ($2,000,000) of seven per cent (7%) cumulative preferred stock, being 20,000 shares of the par value of One Hundred Dollars ($100) each. Three Million Dollars ($3,000,000) of the common stock, being the entire issue thereof, and One Million Dollars ($1,000,000) of the preferred stock, is to be issued full-paid in exchange for the said businesses as going concerns as hereinafter stated, including all of their assets, credits, trade-names, formulae, and good-will, and said incorporated company shall assume all of the outstanding liabilities of the said firms as existing at the time of transfer on the date of final organization. > 3. That the stock of the said corporation shall be issued full- paid as follows: To the aforesaid firm of Lowell, Mason & Com- pany, One Million, Five Hundred Thousand Dollars ($1,500,000) of common stock and Five Hundred Thousand Dollars ($500,000) of preferred stock, distributed to the partners as follows: Robert Lowell, 7.500 shares common and 2,500 shares preferred Walter F. Mason, 6,000 " " 2,000 " Norman Lowell, 1,500 " " " 500 " *W* :J To the aforesaid firm of Oliver & Dickson, One Million, Five Hundred Thousand Dollars ($1,500,000) of common stock and Five Hundred Thousand Dollars ($500,000) of preferred stock, divided equally between the partners. 1 1 74 CORPORATE ACCOUNTING [Bk. III- The remaining stock, being One Million Dollars ($1,000,000) of preferred stock, is to be underwritten by Baker, Wilson & Shaw, bankers, at 95 (5% commission), a contract to that effect having already been executed. 4. And it is covenanted and agreed that Two Hundred Thousand Dollars ($200,000) of common stock shall be returned by the afore- said contracting parties to the corporation, One Hundred Thousand Dollars ($100,000) from each firm, to be treasury stock and to be given to the said bankers free of charge as a bonus with the One Million Dollars ($1,000,000) of preferred stock subscribed by them. 153. Underwriting Expenses In the present instance the amount of preferred stock under- written is $1,000,000, the bankers agreeing to take this entire block at 95, or rather on a 5% commission basis. They then sell the stock to their customers at such higher price as may have been agreed upon or as the conditions permit, the difference between the cost and selling prices representing their profit. It is probable that in a case like this the preferred stock would be sold at par and the $200,000 of common stock be included there- with as a bonus, the transaction bringing the bankers a profit of $50,000, the amount of their commission. To the newly organized company the $50,000 realized by the bankers is regarded as a selling commission, exactly as if the ex- pense of selling the stock had been incurred by the company itself. The bonus of treasury stock given the bankers might be entered on the books, as shown later; or be transferred directly from the stockholders to the banking firm, or to the new pur- chasers, without being entered on the books at all. As the incor- porators have donated the stock, it matters little how the trans- action is handled so long as the desired end is reached, and such receipts or other evidences of it are preserved as will establish the facts should the necessity arise. When stock is underwritten it is not unusual for the bankers to turn over to the company full payment for the underwritten stock; a check for the difference between this amount and the underwritten price being, in turn, given to them. Such amount Ch. 17] INCORPORATION OF PARTNERSHIP is then charged to Commission account or to Underwriting Ex- pense or some other suitable account. This has the merit of bringing the transaction on the books in a very clear and simple manner, and of eliminating from record the appearance of selling stock at a discount. In the present case, however, but 50% of the par value of the underwritten stock ($500,000) is paid by the underwriters at the time, and a check for $25,000 (5% commis- sion on 50% of the underwritten stock) is given to them. The remainder of the underwriters' subscription ($500,000) will be paid later as per agreement. 154. Balance Sheet of Lowell, Mason & Company The balance sheets of the two partnerships, Lowell, Mason & Company and Oliver & Dickson, as of May i, 1922, before the incorporation, are given below. These statements and the data from the agreement for incorporation already given, form the "basis for opening the books of the new company. LOWELL, MASON & COMPANY BALANCE SHEET, MAY i, 1922 Assets Land $ 100,000 Buildings 150,000 Machinery and Tools 115,000 Patents and Patterns 72,800 Trucks and Motors. ...... " 25,000 Fuel and Supplies 12,400 Raw Material 52,800 Work in Process 573o Finished Stock 44iQoo Deferred Charges to Operat- ing 9,250 Investments in Stocks and Bonds 143,700 Notes Receivable 142,000 Accounts Receivable 174,800 Cash .) j^, f 95, 000 < i 'iv $1,194,950 Liabilities Mortgage Payable Interest Accrued Notes Payable Interest Accrued Accounts Payable Accrued Taxes Reserve Accounts: For Depreciation " Bad Debts '..'.' Capital Accounts: Robert Lowell . . $500,000 Walter F. Mason 400,000 Norman Lowell. 100,000 $ 100,000 2,500 40,000 1,500 30,250 6,500 12,000 2,200 1,000,000 $1,194,950 1176 CORPORATE ACCOUNTING 155. Balance Sheet of Oliver & Dickson OLIVER & DICKSON BALANCE SHEET, MAY i, 1922 [Bk. III- Assets Leasehold $ 156,000 Machinery and Tools 85,000 Delivery Equipment 30,000 Fuel and Supplies 9,400 Patents and Patterns 122,000 Raw Material 75.ioo Work in Process 80,900 Finished Stock 198,000 Deferred Charges 12,300 Bonds and Securities 150,000 Accounts Receivable, Net (book value $223,000) . . . 221,500 Cash 134,400 $1,274,600 Liabilities Notes Payable (Secured) . $ 126,000 Accounts Payable 136,300 Interest Accrued 1,600 Accrued Operating Charges 10,700 Capital Accounts : Nelson G. Oliver $500,000 George Dickson . 500,000 1,000,000 $1,274,600, 156. Opening Entries The opening entries for the new corporation must be such as will record correctly and in proper sequence the various transac- tions involved in the incorporation of the company, and in transferring to it, in exchange for its capital stock, the entire plant, business, and net assets of each firm. Those shown below do not differ materially from the entries given in previous chap- ters, except in the manner of making charges for stock. Instead of opening accounts for the various subscribers or even for sub- scriptions, accounts are opened separately for the three different concerns which have subscribed for stock, each firm being charged with the amount of stock to be turned over to its mem- bers, or to whomsoever it directs. A separate entry and expla- nation might be made, if desired, for each firm, or even for each subscriber, but in either case each entry should clearly state the amount of common and preferred stock taken. The entry for stock given to the banking firm might with possible advantage be separated from the others. Ch. 17] INCORPORATION OF PARTNERSHIP "77 May i, 1922 First Entry: Lowell, Mason & Company $2,000,000 Oliver & Dickson 2,000,000 Baker, Wilson & Shaw 1,000,000 To Common Stock $3,000,000 Preferred Stock 2,000,000 The Lowell-Mason Chemical Company is incorporated this day under the laws of Illinois, with a capital stock of $5,000,000, divided into 30,000 shares of common stock of the par value of $100 each, and 20,000 shares of 7% cumulative preferred stock of the par value of $100 each. From the firms above debited subscriptions have been received for the entire common and preferred stock of the Company, the distribution of this stock, as per agreement for incorporation, the subscription list, and the certificate of incorporation, being as follows : Shares Name Common Preferred Robert Lowell 7>5Oo 2,500 Walter F. Mason 6,000 2,000 Norman Lowell 1,500 500 Nelson G. Oliver 7,5o 2,500 George Dickson 7,5 2,500 Baker, Wilson & Shaw 10,000 Total 30,000 20,000 Second Entry: Land $100,000 Buildings . 150,000 Machinery and Tools 1 15,000 Patents and Patterns 72,800 Trucks and Motors 25,000 Fuel and Supplies 12,400 Raw Material 52,800 Work in Process 57,3 Finished Stock 44,9 Deferred Charges to Operating 9,250 Investments in Stocks and Bonds 143,700 Notes Receivable 142,000 Accounts Receivable 174,800 Cash 95,0 Good- Will 1,000,000 To Mortgage Payable $100,000 Interest Accrued . . 4,000 1178 CORPORATE ACCOUNTING [Bk. Ill- Notes Payable Accounts Payable Accrued Taxes Reserve for Depreciation . . . Reserve for Bad Debts .... Lowell, Mason & Company. To record in the ledger the various specific assets and liabilities turned over by Lowell, Mason & Company, as a going concern, in full payment of stock sub- scriptions to 15,000 shares of common and 5,000 shares of preferred stock of the Company, as per agreement for incorporation. (See minute book, page 5.) All right, title, and interest in the assets of Lowell, Mason & Company are conveyed to the Lowell-Mason Chemical Company, and all liabilities of that firm are assumed by the Lowell-Mason Chemical Company, as per agreement for incor- poration. 40,000 3> 2 So 6,500 12,000 2,200 2,000,000 Third Entry: Leasehold $156,000 Machinery and Tools 85,000 Delivery Equipment 30,000 Fuel and Supplies 9,400 Patents and Patterns 122,000 Raw Material 75>ioo Work in Process 80,900 Finished Stock 198,000 Deferred Charges . . ? 1 2,300 .Bonds and Securities 150,000 Accounts Receivable 223,000 Cash 134,400 Good-Will '. 1,000,000 To Notes Payable (Secured) $126,000 Accounts Payable 136,300 Interest Accrued 1,600 Reserve for Bad Debts iiSoo Accrued Operating Charges 10,700 Oliver & Dickson 2,000,000 To record the specific assets and liabilities turned over by Oliver & Dickson, taken by this company as a going concern, as per agreement for incorporation. (See minute book page 5.) Ch. 17] INCORPORATION OF PARTNERSHIP 1179 157. Entries for Commission and Stock Bonus It then remains to make the entries for the payments by the underwriters, showing their commission and the turning over of the donated stock These will be as follows : Fourth Entry: Cash $500,000 To Baker, Wilson & Shaw $500,000 Payment of 50% of subscription of Baker, Wilson & Shaw, underwriters, to $1,000,000 of preferred stock. Fifth Entry: Organization Expense $31,000 To Cash $31,000 By order of the Directors for payment of various expenses incurred during the incorporation of the Company, including 5% commission to Baker, Wilson & Shaw on $500,000 of stock subscription. (Give items in detail.) Sixth Entry: Treasury Stock Common $200,000 To Stock Donation Account $200,000 2,000 shares of common stock donated to the Com- pany in accordance with the agreement for incor- poration, as follows: Lowell, Mason & Company 1,000 shares Oliver & Dickson 1,000 " '-;-.>rtm<. ni ^DoJfj Seventh Entry: Stock Donation Account . . . $200,000 To Treasury Stock Common : . . . . '.' ( -' $200,000 For the bonus of 2,000 shares of common stock trans- ferred to Baker, Wilson & Shaw as per underwriting contract, being one share of common stock for every five of preferred stock underwritten. This stock has been donated by the incorporators and is full-paid and non-assessable. An amount of $500,000 of the underwriters' stock subscrip- tion still remains to be settled for as per agreement, at which time Cash and Organization Expense will be increased and the account with Baker, Wilson & Shaw closed out. n8o CORPORATE ACCOUNTING [Hk. III- 158. Closing the Partnership Books . r - - . * The manner of closing the partnership books will be illus- trated in detail by the closing entries for Lowell, Mason & Com- pany. A somewhat different procedure is shown in condensed form in closing the books of Oliver & Dickson. It is not unusual, when a partnership is incorporated, for the bookkeeping system, if well-arranged, to be retained and be used by the new company, rather than to open new books. When that is the case, only such entries are required as are necessary to open the accounts peculiar to the corporation and record the transactions incident to incorporation. However, in the case now under consideration new books are presumed to have been opened, and of course all asset and liability accounts must neces- sarily be closed on the partnership books and the balances be transferred to the corporation's accounts. It will be noticed that each firm has been allowed $1,000,000 for its good-will in addition to payment in full for its net worth. The amount may be too much, but that is a matter with which the accountant is not particularly concerned since this has already been determined and he must accept conditions as he finds them. The two firms receive stock of the new company in exchange for their respective plants and net assets; and this stock in turn is apportioned to the former partners in proportion to their holdings as set forth in the agreement. The successive entries shown below exhibit in proper sequence the procedure and book entries required. 159. Closing Entries on Books of Lowell, Mason & Company The following entries will properly adjust and close the ac- counts of Lowell. Mason & Company. The same end could be reached by different series of adjusting entries. May i, 1922 Good- Will $1,000,000 To Robert Lowell $500,000 Walter F. Mason 400,000 NormanLowell too.ooo Ch. 17] INCORPORATION OF PARTNERSHIP Il8t To place upon the books good-will of $1,000,000 in accordance with agreement for incorporation of the Lowell-Mason Chemical Company entered into . ., _ ^ J Ml * J J- Apnl 28, 1922. Good-will apportioned according to the partners' holdings. Lowell-Mason Chemical Company $2,194,950 To Land $100,000 Buildings 150,000 Machinery and Tools. . 1 1=5,000 Patents and Patterns 72,800 Trucks and Motors rV. . 25,000 Fuel and Supplies 12,400 Raw Material 52,800 Work in Process. . S7,3oo T7- U J C4. 1 finished Stock 44,Qo 7-> c j /n. t /-, Deferred Charges to Operating 9,250 Investments in Stocks and Bonds '.'. 143,700 Notes Receivable 142,000 Accounts Receivable '^.'t. . .Tf."/! ..... 174,800 Cash 95,000 Good-Will 1,000,000 Plant, good-will, and sundry assets turned over to the Lowell-Mason Chemical Company in exchange for $2,000,000 par value, of stock of that Company, as per agreement for incorporation. Mortgage Payable $100,000 Notes Payable f ,, 40,000 Interest Accrued 4,000 Accounts Payable j .> 30,250 Accrued Taxes. . . : . . .(^n^h v&ft&'-l- 6,5 Reserve for Depreciation . . 12,000 Reserve for Bad Debts 2,200 To Lowell-Mason Chemical Company. . WOfM CV $194,950 To close accounts and transfer to Lowell-Mason Chemical Company all of the liabilities of this firm, as per agreement for incorporation. 1 60. Distribution of Partnership Assets All assets and liabilities have now been closed off and tran>- ferred to the new corporation; and the only accounts remaining open are the capital accounts of partners and the debit balance of the Lowell-Mason Chemical Company. The required amount 1 1 82 CORPORATE ACCOUNTING [Bk. III- of stock has been received from the new company to pay for the $2,000,000 of net assets turned over. This stock is distributed to the former partners as originally agreed, and entered on the books as follows: Stock of Lowell-Mason Chemical Company $2,000,000 To Lowell-Mason Chemical Company $2,000,000 For 20,000 shares of stock of Lowell-Mason Chemical Company received today in full payment for net assets shown in the previous entries. The stock is issued in the partners' names as follows: Shares Com- Pre- Par Names mon ferred Value Robert Lowell 7iSoo 2,500 $1,000,000 Walter F. Mason 6,000 2,000 800,000 Norman Lowell i,5o 500 200,000 Total 15,000 5,000 $2,000,000 Robert Lowell $1,000,000 Walter F. Mason 800,000 Norman Lowell 200,000 To Stock of Lowell-Mason Chemical Company. . . $2,000,000 For distribution of the above-mentioned stock to the partners, and to close the capital accounts of the firm. 161. Closing the Books of Oliver & Dickson The entries below illustrate another plan of closing the part- nership accounts. These entries are condensed as much as pos- sible so as to show merely the procedure rather than the record of details such as was shown in the previous closing entries. Good- Will $1,000,000 To Nelson G. Oliver $500,000 George Dickson 500,000 (Full explanation here.) Lowell-Mason Chemical Company $2,000,000 Sundry Liabilities (listed separately) 276,100 To Good-Will and Sundry Other Assets (listed separately) $2,276,100 (Full explanation here for transfer of all assets and liabilities.) Ch. 17] INCORPORATION OF PARTNERSHIP Nelson G. Oliver $1,000,000 George Dickson 1,000,000 To Lowell-Mason Chemical Company To close capital accounts of the partners upon dis- tribution to them of stock of the Lowell-Mason Chemical Company: Shares Name Common Preferred Nelson G. Oliver .- . 7,500 2,500 George Dickson 7,5oo 2,500 n8 3 $2,000,000 Total 15,000 5,000 162. Balance Sheet of New Company LOWELL-MASON CHEMICAL COMPANY BALANCE SHEET AS ON MAY i, 1922 Assets Land $ 100,000 150,000 200,000 194,800 156,000 25,000 30,000 21,800 127,900 138,200 242,900 21,550 293,700 142,000 397,800 698,400 500,000 31,000 2,000,000 Liabilities Mortgage Payable $ 100,000 166,000 166,550 5,600 17,200 12,000 3,7oo 3,000,000 2,000,000 Buildings Notes Payable Machinery and Tools Accounts Payable Patents and Patterns Interest Accrued Leasehold Accrued Taxes and Charges Reserve Accounts: For Depreciation Trucks and Motors Delivery Equipment Fuel and Supplies " Bad Debts Raw Material Capital Stock: Work in Process Finished Stock Preferred, 7% Cumulative Deferred Charges to Operat- ing Investments Notes Receivable Accounts Receivable Cash Subscriptions to Stock Organization Expenses . . . Good-Will $5,471,050 $5,471,050 1184 CORPORATE ACCOUNTING [Bk. Ill- The accompanying condensed balance sheet of the new cor- poration shows the combined assets and liabilities and capital stock resulting from the merger. The balance sheet of each firm as already given shows its condition at the time of the incorporation. To the value shown, add $1,000,000 for good- will to the net capital of each firm to get the value placed upon its business. On the books of the .new company the assets and liabilities taken over from the two firms are, of course, to be combined in the respective accounts, as shown in the balance sheet herewith. O.v, . 1&Q Part IV Bonds and Funds CHAPTER XVIII BOND RECORDS AND ACCOUNTSi 163. Treasury Bonds f Bond issues are usually authorized for a stated amount, and the bonds are then sold at such times and in such amounts as the conditions permit. All bonds of the same issue usually bear the same date regardless of the date of sale, and any coupons which have matured before the particular bonds are sold, are clipped off, canceled, and pasted in the coupon register. The authorized bonds which have not been sold are sometimes called "treasury bonds," which designation ordinarily includes the entire amount of authorized bonds not disposed of by the issuing company. Some accountants, however, prefer to give the term the same meaning as when employed in connection with stock, designat- ing as treasury bonds only such bonds of the company as have come back into its possession by purchase or otherwise, for in- vestment or for sinking fund purposes. 164. Issued and Outstanding Bonds The following paragraph, taken from the accounting classifi- cation of the Interstate Commerce Commission, indicates its designations of bonds before and after the issue thereof : For the purposes of the balance sheet statement, funded debt securities are considered to be nominally issued when certified by trustees and placed with the proper officer for sale and delivery, or pledged, or otherwise placed in some special fund of the accounting ' For general discussion of bonds, see Book I, Chs. LIV, LV; and Book II, Part II, "Cor- porate Securities." 1185 n86 CORPORATE ACCOUNTING [Bk. Ill- company. They are considered to be actually issued when they have been sold to a bonafide purchaser for a valuable consideration, and such purchaser holds them free from all control by the account- ing company. All funded debt securities actually issued and not reacquired and held by or for the accounting company are con- sidered to be actually outstanding. If reacquired by or for the accounting company under such circumstances as require them to be considered as held alive and not cancelled or retired, they are considered to be nominally outstanding. The term "treasury bond" is not used in the Commission's classification. It is understood by the Commission, however, to cover either nominally issued or nominally outstanding bonds which are held by the corporation in its treasury upon its own behalf. It may be said that this is the stand taken by public utility commissions also, but the accountant or corporation official may freely use whatever caption for accounts he may de- sire, so long as it is one that is clearly understood by all concerned and the corporation is not subject to commission regulations. 165. Accounting Records for Bonds Under some conditions transactions in bonds require no de- tailed record to be kept by the issuing corporation. If the bonds are sold through an underwriting syndicate, or through a bank or trust company which acts as transfer agent and registrar, this is always true. If, however, registered bonds are sold by the corporation direct, the treasurer or the accounting department must keep a full record, and for this purpose a bond register is necessary. Registered bonds are of two classes: (i) bonds which are registered both as to principal and interest, interest checks being issued on the specified interest dates direct to the holders of record; and (2) bonds which are registered as to principal only, the interest being represented by coupons and therefore payable to the holders of these coupons upon their surrender. 2 As explained later in the chapter, if coupon bonds are issued, * See Book I, J 500. . Ch. 18] BOND RECORDS AND ACCOUNTS 1187 a coupon register should also be kept. An index of bondholders is also usually maintained. This is merely a card list on which is entered the name and address of each bondholder, together with the number of his bond, its amount, and such other data as may be desirable. The card also provides for a record of the per- son from whom the bond was transferred, in case it is not an original issue, and blanks for the name of the person to whom it may be transferred. 1 66. The Bond Register 3 The bond register provides space for the name and address of the holder, the number of his bond, the date it was acquired, the name of the transferee, and 20 columns for 20 interest payments. Thus a complete record is provided for a lo-year bond on which Interest is payable semiannually. When a registered bond is transferred, a new one is issued on surrender of the old, just as a new stock certificate is issued when stock is transferred. The surrendered bond is canceled and filed, and in the bond register a red-ink line is ruled through the name and address of the former owner, and through the number and amount of the canceled bond itself. Also the number of the new bond is written directly after the last entry of interest payment on the old bond, as indicated on the form shown. A line ruled through the remaining interest columns then completely cancels the line devoted to the canceled bond, though the original entry still shows the transfer of the old bond and the number of the new bond by which it was replaced. The name and address of the owner of the new bond is then recorded on the first vacant line of the bond register in the column headed "To Whom Is- sued," and the record of the transfer is complete. As will be noted, the bonds are entered in numerical order, and any special bond may be readily located if its number is known. If the number is not known but the name of the owner is, the bond may be traced through the index of bondholders. If * See Book IV, Forms 2Sga, asgb. n88 CORPORATE ACCOUNTING [Bk. Ill- desired, the number of the page of the bond register on which the individual's name appears can be entered on the index of bond- holders. 4 The difference between the footings of the "Amount" columns of the bond register and the sum total of all bonds canceled which is obtained by adding together all amounts through which the red-ink line is drawn should agree with the balance of the Bond account in the general ledger. 167. Payments of Interest on Non-Coupon Bonds If the bonds are not coupon bonds, interest is computed on each at the half-yearly or yearly interest dates, and recorded under the proper interest period in the bond register. At the same tune, interest checks are issued to the registered holders. The sum total of the footings of the Interest columns should agree with the total amount of interest checks issued, and is charged through the cash book to the Accrued Interest on Bonds account. This is on the assumption that accrued bond interest is entered monthly or at least prior to the date of payment. Interest checks are made out direct from the bond register. For the sake of accuracy, it is advisable to arrange these interest checks alphabetically and compare the names of the payees with the names shown by the cards of the index of bondholders. This reduces to a minimum the possibility of checks being made pay- able to the wrong person. The register for coupon bonds does not show interest pay- ments, but merely the ownership of the bonds. In such case the rulings for interest payments are omitted. The bonds are en- tered as presented for registry rather than numerically as is the case with registered bonds. 1 68. Payment of Coupons Coupons are generally presented for payment at the office of the fiscal agent or trustee, in envelopes specifying the title of the 4 See Book IV, Form 260, "Index of Bondholders." Ch. 18] BOND RECORDS AND ACCOUNTS 1189 security, number and amount of the coupons, and the name of the concern or individual presenting them. Payment is made by check when possible, and of course out of funds supplied by the issuing corporation. The coupons arc canceled by having one or more holes punched in them; all canceled coupons are kept together, and at proper intervals are sent to the company which issued the security, with a statement of the account showing the total coupons paid and the amount still outstanding. 169. The Coupon Register & Coupon bonds registered as to principal are entered in the bond register, and an alphabetical card index of bondholders is provided for each denomination of bonds issued. A coupon regis- ter is also provided for the proper record of paid coupons. If coupon bonds are not registered, but are transferred by de- livery, the bond register and the card index of bondholders are of course unnecessary, the coupon register alone being maintained. An entire page of the coupon register is required for the record of each bond, and all paid coupons belonging to that bond are pasted on the page allotted to it in the space numbered to corre- spond with the particular coupon. The method of using the cou- pon register is simple. As will be noted, the number, the amount, and a brief description of each bond are entered at the top of the page devoted to that bond. As each coupon comes in and is paid, it is pasted over its number on this page. A glance at the coupon register will therefore show at any time what coupons have been paid and also what coupons are due but unpaid. A special bank account should be kept for the payment of coupons, and the balance of this bank account should agree with the total due and unpaid as shown by the coupon register. 170. Accounts Used Bonds may sell at, or below, their par value, or at a premium, depending in part upon the stability of the issuing company and 'Book IV, Form 261. IIQO CORPORATE ACCOUNTING [Bk. III- the rate of interest to be paid. The bonds may be all or partly sold at the time of issue, and those that have been disposed of may be paid for in monthly or periodical instalments. In any case there are numerous expenses incident to a bond issue, and these may either be charged immediately to operating expenses or spread over a term of years. The financing of corporations through bond issues has already been discussed. 6 The accounts used for recording sales of bonds are analyzed in the following sections. It will be seen that they correspond rather closely with similar accounts for handling capital stock transactions, 171. Bonds Authorized Account Debit: With the par value of bonds retired. Credit: With the par value of bonds au- thorized for issue. The uses of this account may be considered as parallel to those of the Capital Stock Authorized account. 7 Just as was suggested in that connection, separate accounts should be opened with each different series of bonds authorized, the nature of each issue being clearly set forth by the title of its account, as Author- ized First Mortgage 5% Bonds of 1940, Collateral Trust 5% Bonds Authorized, First Mortgage 30- Year Sinking Fund Gold Bonds Authorized, etc. 172. Bonds Unissued Account 8 Debit: With the par value of bonds au- thorized for issue. Credit: With the par value of bonds issued. The difference between the balance of this account and the balance of the Bonds Authorized account represents, paralleling the equivalent capital stock accounts, the par value of the bonds outstanding. 6 Book II, Part II, "Corporate Securities." 'See {{33, 34- 'Separate account for each series of bonds. See } 171. Ch. 18] BOND RECORDS AND ACCOUNTS 1191 173. Bonds Account Not all authorities consider it necessary to show the amount of the authorized bonds and of those unissued on the books, pre- ferring to enter only those issued as credits to a Bonds account 9 whose functions are as follows: BONDS Debit: With the par value of bonds retired. Credit: With the par value of bonds issued or assumed. The use of this single account, the balance of which represents the par value of the bonds outstanding, is more satisfactory than 's the use of the single Capital Stock account. 10 When it is used it is well to show the amount of the authorized issue as a paren- thetical note at the top of the Bonds account. The objection raised to the failure to show the amount of the authorized issue on the books and on .financial reports, is that by the authorization a mortgage liability of that amount has been placed on certain assets or income, effective when, and to the amount for which the bonds are sold. The showing of only the amount of bonds issued would, when that is less than the author- ization, fail to indicate the true amount for which the property would become mortgaged without further action than the sale of more bonds. / .fin .-Juuil ,fi; ' .,[ no 174. Bond Premium Debit: With amounts of premium amortized. Credit: With premium received on bonds sold above par. This account when it exists has a credit balance and shows the amount of bond premium not yet written off. This premium is not a profit which should be used for the payment of dividends. On the balance sheet the balance of the account is usually carried among the deferred credit items on the liability side. Separate account for each series of bonds. See | 36. IIQ2 CORPORATE ACCOUNTING [Bk. III- The amortization of bond premium presents a number of problems which are discussed in a later chapter." 175. Bond Discount Credit: With amounts of discount amortized. Debit: With the discount allowed to bankers or underwriters on sale of the com- pany's bonds. With other bond issue expenses in- curred at the date of issue. This account is a deferred expense which is usually spread over a term of years. If, however, the profits will justify, it may be all charged off during the first one or two years. It is the practice to charge to this account all expenses incident to floating a bond issue. Such expenses are common to nearly all cor- porate bond issues, and are usually written off over the life of the bonds. The methods of handling this are discussed in a later chapter. 12 176. Interest on Bonds 13 Credit: Balance of this account constitutes a fixed revenue charge, and should be transferred to Profit and Loss account when the books are closed. Debit: At the close of each month, or fiscal period if monthly profits are not as- certained, with the amount of interest on bonds outstanding applicable to the month or fiscal period just ended, as the case may be. The corresponding credit is to Accrued Interest on Bonds. When the cash receipts and disbursements method of ac- counting is used instead of the accrual method, the debits to this account will consist of the amounts of interest paid, the corresponding credit being to Cash. The account would be closed into Profit and Loss as by the accrual method. " See Ch. XXI. "Bond Discount and Premium.' " Ibid. See also Ch. XX. "Bond Interest." Ch. 18] BOND RECORDS AND ACCOUNTS 1193 177. Accrued Interest on Bonds Debit: With payments of interest on bonds outstanding. Credit: At the close of each month, or fiscal period if monthly profits are not ascertained, with the amount of interest accrued on outstanding bonds during the month or fiscal period just ended, as the case may be. The corresponding debit is to Interest on Bonds. The balance of this account is a liability, and represents inter- est accrued and not due. Since in most large corporations it is the practice to require monthly profit and loss statements and balance sheets, accruals of interest on bonds, mortgages, and other obligations must be set up in the general ledger accounts. 178. Funds and Reserves There are a number of accounts having to do with sinking and redemption funds and with various reserves, discussion of which is deferred to Chapter XXII, "Principles of Fund Accounting." CHAPTER XIX BOND SALES 179. First Mortgage Bonds Sold at Par To illustrate the sale of bonds at par, we will assume that the directors and stockholders of the Lenox Iron Works have author- ized January i, 1922, an issue of first mortgage gold bonds for $1,000,000, rfaving 20 years to run, with interest at 5%, payable semiannually on the first day of January and July. The bonds are coupon in form with the privilege of registration as to principal. Under these circumstances, it might be permissible to ignore the matter as far as the books of account are concerned, until the bonds are sold, at which time an entry would be made only for those sold, as shown below. It seems prudent, however, to have a transaction of such importance placed upon the books immediately. For this purpose, at the date of issue and before sale of the bonds, an entry is made as follows : January i, 1922 Unissued First Mortgage Bonds $1,000,000 To First Mortgage Bonds $1,000,000 Authorized issue of $1,000,000 first mortgage 5% 2o-year gold bonds as sanctioned this day by the directors and stockholders. Instead of "Unissued Bonds," some other appropriate title for the account may be used, if desired, as "First Mortgage Treasury Bonds," "Unsold First Mortgage Bonds," etc. The credit entry may, if desired, be made to "First Mortgage Bonds Payable," "Authorized First Mortgage Bonds," "Bonds Pay- able," or any other caption that will designate the issue clearly. If there are different issues, the caption may distinguish them by indicating the interest rate, the life, or the due date of the bonds, 1194 Ch. 19] BOND SALES 1195 as "First Mortgage 5% Gold Bonds of 1950" or "First Mortgage 6% 20- Year Bonds," etc. 1 80. Entry of Sale of Bonds If the entire issue of bonds is sold by the issuing company for cash, the following entry should be made: Cash $1,000,000 To Unissued First Mortgage Bonds $1,000,000 Sale at par of trie entire issue of first mortgage bonds as authorized by the directors. In case the bonds are paid for in property of some kind, then of course the property received is debited in place of cash. If the bonds were not recorded on the books at the time of authorization, the cash book entry would be: .''''JTilfif Cash $1,000,000 To First Mortgage Bonds $1,000,000 Sale at par of the entire issue of first mortgage 5% ao-year gold bonds as authorized by the Directors. In case only a part of the bond issue has been taken at the date of issue, then a cash book entry, to Unissued Bonds account must be made for only the sum taken. Subsequent sales of bonds for cash should be recorded in the same manner. In the sale of bonds after date of issue, however, the element of accrued interest is involved in the sale price and must be included. 181. Bonds Sold at Par and Accrued Interest Inasmuch as the entire bond issue bears the date of authori- zation, it is apparent that interest will have accumulated on all bonds sold on subsequent dates. It matters not whether the bonds are sold at par or otherwise ; interest will .have accrued on the par value thereof to the date of sale, and the investor is ex- pected to add it to the purchase price of the bonds. In that case the cash book entry would be as follows, assuming that $500,000 of bonds were sold three months after the bonds were issued. 1196 CORPORATE ACCOUNTING [Bk. Ill- April i, 1922 Cash $506,250 To Unissued First Mortgage Bonds t . $500,000 First Mortgage Bond Interest 6,250 Sale of $500,000 of first mortage bonds and accrued interest on same at 5% for three months. The payment by the purchaser of this accrued interest in- volves no loss to him except the interest which the $6,250 so paid might earn from April i until the next interest date, three months later. His payment at this time is merely a refund (in advance) of the interest which he has not earned and which will be paid to him when he cashes his first coupons for six months' interest. Three months after the date of his purchase the com- pany will pay the entire interest on all outstanding bonds for the first half-year; at that time the purchaser will receive back the interest money advanced by him, and in like manner the com- pany will return the interest thus received. If the sale were de- ferred until the first or some subsequent interest date, accrued interest would not enter into consideration at all, for at that time the company would clip all coupons from the unsold bonds and, after cancellation, paste them in the coupon register. 182. Bond Subscriptions Paid for in Instalments If bonds are sold directly to the public by the issuing com- pany, or even through brokers on a commission basis, it is not unusual to allow the purchasers a term of months in which to make their payments, the instalments being due at designated intervals. If the present bond issue had been sold to subscribers on the instalment plan, the entry would be : January i, 1922 Bond Subscriptions $1,000,000 To Unissued First Mortgage Bonds $1,000,000 Sale of $1,000,000 of bonds to sundry subscribers at par, payable one-quarter down and the balance in three monthly payments of one-quarter each on the first day of each month. (Names of subscribers should be entered on separate sheets or in a subsidiary sub- scription ledger provided for the purpose.) Ch. 19] BOND SALES 1197 Bond Subscriptions should be credited as payment of each instalment is made, and official receipts be issued therefor. When payments are completed, the instalment receipts are re- turned and the bonds issued. The deferred instalments may per- haps bear interest at a given rate, or at the same rate the bonds are to draw, in which case an additional credit to Bond Interest account for the interest received is necessary, which in turn will offset an equivalent charge to the same account. Monthly bal- ance sheets made during the interval would of course show the amount of bond subscriptions deferred. Instalment payments may obtain when bonds are sold to the company's bankers. In that event the entire contract amount, after allowance for discount, if any, should be charged up to the orokers as shown below: Barton & Day, Bankers $1,000,000 To Unissued First Mortgage Bonds (or to First Mortgage Bonds) . . . . $1,000,000 Entire issue of first mortgage bonds sold at 100 flat, pay- able $400,000 down and the balance in two instal- ments of $300,000 each, due in one and two months respectively. Credit is of course given Barton & Day as payments are made by them. > 183. Guaranteed Bonds When bonds of one corporation are guaranteed by another corporation, it is manifest that the guaranteeing corporation must constantly hold itself in readiness to pay the bond interest upon any default on the part of the issuing company; but were such payment made, it would be considered only as an advance or loan to the subsidiary company, from whom repay- ment would be expected at some future date. The entries to be made on the issuing and guaranteeing companies' books should be in harmony. The decision as to whether or not a ledger entry is required by either company at the time bonds are guaranteed, as an official 1 1 98 CORPORATE ACCOUNTING [Bk. Ill- record of the conditions, depends on the wishes of the directors. If a minute of such guarantee is clearly set forth in the official records of each company, that should suffice, since the fact of the guaranty is conspicuously stated in the bonds themselves as well as in the deed of trust. A footnote of the guaranty should of course be made on the balance sheet of the guaranteeing com- pany. 184. Collateral Trust Bonds Collateral tmst bonds are bonds secured by a deposit of stocks and bonds of other corporations. The book entries for transac- tions in such bonds do not differ materially from those required for recording regular mortgage bonds. With the mortgage bond, however, though a conveyance under trust mortgage is made to the trustee, the real estate security remains in the company's possession; while in the case of the collateral bond, all of the security is placed in the hands of the trustee. The terms of the trust indenture usually provide that the collateral may be changed at any time for other collateral of equal value, either at the request of the issuing company or of the trustee. The collateral security must be conveyed to the trustee before the actual sale of bonds begins, though this conveyance does not deprive the company of its rights and privileges as owner of the collateral, such as voting at meetings of stockholders, receiving the income from its investment, etc. The question now arises: What kind of record should be made for the collateral deposited with the trustee? An adequate record of the transfer should of course be made in the official minutes, and the Public Service Commission of New York requires that the pledged collateral must be set forth in an account by itself. Corporations not sub- ject to commission regulations may make entries in any logical manner, but in all cases it seems desirable to set forth in a sep- arate account all pledged securities. See Book II, 91. Ch. i9l BOND SALES 1199 185. Entries for Collateral Trust Bonds The stocks and bonds used as collateral, when first purchased, are usually entered on the books at the purchase price regardless of par value, and are charged to some representative account, as "Investments" or "Stocks and Bonds of Other Companies," or to accounts representing the kinds of securities purchased. On the assumption that the collateral is standing in an "In- vestments" account and has a book valuation of $1,340,0x50, the following entry is required suitably to record the conditions: Pledged Investments (to secure collateral trust bonds) .... $1,340,000 To investments ,jf j * $1,340,000 To record the pledge of the following collateral with the Hudson Trust Company, as security for the issue of $1,000,000 collateral trust bonds: (Here list details of the stocks and bonds pledged.) The above entry removes the collateral entirely from the In- vestments account and leaves therein only such securities as are still in the company's possession; while the Pledged Investments account exhibits the book value of securities in the trustee's pos- session. In a manufacturing corporation an account might be opened with the trustee and the collateral security stated therein. If there are several bond issues, it is desirable to have separate accounts for the pledged collateral belonging to each issue. In case the market value of pledged collateral falls below a given margin of safety, the trustee may call for an additional deposit. Corporations which have a considerable investment in stocks and bonds usually provide separate books for recording the de- tails of such investments. When this is the case, a notation in the accounts affected might perhaps be considered a sufficient record of securities deposited as collateral, but the entry shown above is preferable since it provides a more systematic record. 186. Entries for Short-Term Notes The opening entries for short-term notes do not differ from those required for collateral trust bonds. An entry should of course be made crediting the entire issue of notes under whatever 1200 CORPORATE ACCOUNTING [Bk. III- caption is necessary, as "Three- Year Notes/' "Two-Year Col- lateral Trust Notes," etc., and debiting the cash received and selling expense. In case the notes are secured by collateral, an entry for the collateral is necessary as already explained. 187. Entries for Equipment Trust Serial Bonds To illustrate the entries required when equipment trust bonds are sold, assume that the Green Valley Railway Company has issued equipment trust 5% gold bonds dated July i, 1921, for $4,000,000, payable in instalments of $400,000 each year begin- ning July i, 1922; the bonds are secured by new standard equip- ment costing $5,000,000, upon which an initial payment of $1,000,000 has been made by the company. Since the issue of equipment or car trust certificates is subject to commission regu- lations, these regulations must be followed in making the entries. Assuming that the equipment was purchased through, and the bonds given to, Murray Brothers & Co., bankers, at 95, that a trust mortgage is made to a trustee as security for bondholders, and that expenses connected with the issue amount to $6,000, the required entries are as shown below. When the trust is created and the first payment of 20% is made on account of the equipment, the entries are : July i, 1921 Equipment $1,000,000 To Cash $1.000.000 Initial payment of 20% on the following equipment costing $5,000,000 purchased through Murray Brothers & Co., for which $1,000,000 is paid in cash and the balance is satisfied by equipment bonds. (Here give details of the equipment and bonds, or else refer to the agreement where they can be found.) Leased Equipment $4,000,000 To Equipment Trust 5% Bonds $4,000,000 For issue of equipment trust bonds in denominations of $ 1,000, being balance of payment of equipment pur- chased through Murray Brothers & Co., Bankers, as per trust agreement. The bonds mature $400,000 on July i of each year during the next 10 years. Ch. 19] BOND SALES 1201 If thought preferable, these payments might be put through the account of the bankers, who are holders of the lien; Equip- ment and Leased Equipment being debited and the bankers credited with the entire purchase price, as shown below: Equipment $1,000,000 Leased Equipment 4,000,000 To Murray Brothers & Company $5,000,000 (Full explanation here.) Murray Brothers & Company $1,000,000 To Cash $1,000,000 Murray Brothers & Company $4,000,000 To Equipment Trust 5% Bonds $4,000,000 (Full explanation here.) The entry for the expense connected with the issue would be : Expense on Equipment Trust Bonds $6,000 To Cash $6,000 As each bond instalment matures and is paid, an entry is re- quired in the bond account and also in the Equipment account, since the portion paid must be transferred from "Leased Equip- ment" to the "Equipment" account. The equipment is required, of course, to be fully and adequately maintained by the operating company. The entries for interest are required to be made semi- annually, and monthly adjustments should be made to distribute the interest over its period. The instalment entries are : July i, 1922 Equipment Trust 5% Bonds $400,000 To Cash $400,000 First instalment on equipment trust bonds paid this day, per trust agreement. At the same time, and at each instalment date thereafter, the following transfer entry is required : Equipment $400,000 To Leased Equipment $400,000 For transfer to the Equipment account, of property covered by current instalment. BOND INTEREST 1 88. Paying Bond Interest Bond interest is usually paid semiannually from the date of issue, but the deed of trust may specify that it shall be paid quarterly or annually. Interest on registered bonds is paid to the registered holders by checks sent out at interest periods by the company itself or by its fiscal agent, while interest on coupon bonds is paid upon presentation of the coupons at the office of the company or of its fiscal agent. The coupons are sometimes made payable at any one of two or three different agencies. Owners of coupons may either send them direct to the issuing company or agency and receive a cash remittance in exchange, or deposit them in their local banks for collection. 1 189. Method of Handling Interest Coupons Using the bond issue of $1,000,000 5% gold bonds of the Lenox Iron Works, cited in the preceding chapter, we assume that the first interest date, July i, 1922, has arrived and that $25,000 has been turned over to the company's fiscal agent for payment of the coupons as they are presented. On the com- pany's books the only entry required at the time is the following, which of course should appear in the cash book : July i, 1922 Bond Interest $25,000 To Cash $25,000 For payment of semiannual bond interest on $1,000,000 5% bonds, due today at the office of the trustee, The Grove Street Trust Company, to whom the check has been issued. !See 55 167, 168. 1202 Ch. 20] BOND INTEREST 1203 This entry is made immediately on sending the interest check to the trust company or bank where the coupons are payable. This check is usually sent the day before the interest is payable or perhaps sooner, depending on the distance. When the coupons are paid and canceled, they are then turned over to the issuing company and pasted in the coupon register or otherwise disposed of. 190. Recording Interest Liability In case the interest coupons are payable at the office of the company, it is obvious that, with the simple accounting system assumed, no entry would be necessary until the coupons were presented and paid. Even when the coupons are payable at the company's office, a special bank account is frequently opened for their payment, a check being drawn for the full amount and deposited in this account. If the coupons were all paid on the due date, the entry would be similar to that given above, the credit being to the special account and the explanation being changed to show that payment was made at the office. It is rarely, however, that this happens, and when it is not the case, entry is o.f course made only for the coupons presented and paid. The amount still outstanding can easily be calculated, but the bond interest account itself will not show its correct debit until all of the coupons have been paid. It is apparent, therefore, that at the end of each year the books must either be kept open until all coupons come in, or present an incomplete record comprising only such bond interest as has been paid. Neither of these plans meets the needs of present-day accounting. The most approved plan is to set up at each interest date the amount of interest due. Assuming that this plan is adopted,, the following entry is nec- essary at the end of the preceding month: June 30, 1922 Bond Interest $25,000 To Bond Interest Payable $25,000 For half-yearly bond interest due and payable tomorrow. 1204 CORPORATE ACCOUNTING [Bk. III- Instead of "Bond Interest Payable," the account might be termed "Coupons Payable." There is a difference between interest "due and payable" and interest "accrued." For instance, on June i, 1922, the larger portion of the interest on the bonds for the period under consideration has accrued, but it is not due and payable until July i, 1922. Outstanding coupons continue to be obligations of the com- pany until paid. As the coupons are redeemed, charges are made against Bond Interest Payable account, so that the excess credit to this account will show at any time the liability on out- standing coupons. If there are several bond issues, an Interest Payable account might be set up for each. Assuming that all of the bond coupons were paid by the com- pany on the due date, we have the following entry: July i, 1922 Bond Interest Payable $25,000 To Cash . .' $25,000 For interest coupons presented and paid this day. At the time of each book closing, the Bond Interest account should be closed into Profit and Loss or into such other account as the system in use may call for. 191. Bond Interest Accrued Nearly all large corporations require monthly statements of income and operating expenses and statements of condition, so that it becomes necessary at the end of each month to compile the various expenses belonging to that period. These expenses obviously comprise not only the current expenses and pay-roll, but a proportionate share of prepaid and accruing charges, as interest, discount, taxes, insurance, etc. Bond interest is gen- erally payable half-yearly, so that -each monthly statement should include one-sixth of the half-yearly fixed interest charge. As an offset to each monthly interest apportionment, a corre- sponding credit is set up to "Accrued Bond Interest," or "Accrued Interest Coupons," or "Accrued Bond Coupons," or some other Ch. 20] BOND INTEREST 1205 account that will clearly designate the interest obligation. Such entries are made through the journal. For example, referring to the previous illustration, if the half-yearly bond interest of $25,000 is to be accrued in monthly proportions, an entry is required at the end of each month as follows: January 31, 1922 Bond Interest $4,166.67 To Bond Interest Accrued *,y . ji^iU. -j $4,166.67 Accrual of interest on $1,000,000 of 5% bonds for month of January. A similar entry should be made at the end of each succeeding month. A like entry is necessary for registered bond interest, and for interest on any other bond or mortgage obligation, and even for interest accruals on current liabilities. Monthly entries are advisable also for interest accruing on investments and receivables, especially when monthly statements are required. At the end of each six months the bond interest is paid, Cash being credited, and the Bond Interest Accrued account closed by the corresponding debit; but whether or not the Bond Interest account is closed at the same time depends on the closing dates adopted by the company. As a rule it remains open until the end of the fiscal year, so that at any time during the year it shows the cumulative total for all of the months as well as the interest for each month. Sometimes the ledger accounts are closed monthly, in which case the Bond Interest account is closed into Profit and Loss twelve times a year. 192. Interest on Registered Bonds In the case of registered bonds, interest checks are usually sent by the treasurer of the company direct to the holders, though not infrequently the checks are sent by the fiscal agent. They are usually mailed so as to reach the payees on the date when the interest is due or as soon as possible thereafter. The book entries for accruing and paying interest on registered bonds do not differ from those required and illustrated for interest on 1206 CORPORATE ACCOUNTING [Bk. Ill- coupon bonds. An alphabetical list of the registered bondhold- ers entitled to receive interest checks must be prepared for each interest period. 193. Interest on Two or More Bond Issues Definite examples of entries to fit all bond interest conditions cannot well be given. Those already given, with those which follow, illustrate their general character and are in accordance with the entries employed by many of the larger corporations. Each entry must indicate for what purpose it was made and the conditions involved. Monthly entries are made for accruing bond interest on the various bond issues and for the several series of any particular issue. An account is opened for each separate obligation as a rule, and sometimes for each part issue thereof. As a basis for the entries which follow, assume that on January i, 1922, first mortgage 5% bonds are issued for $2,000- ooo, interest payable April i and October i; also first and re- funding 6% mortgage gold bonds for $4,000,000, interest payable January i and July i. At the end of June, the following entry is necessary to record the interest accruals for the month, similar en cries having been made for the intervening months. June 30, 1922 Interest on Funded Debt $28,333.34 To Accrued Interest on Bonds $28,333.34 Monthly interest accrual on outstanding bonds as follows: Bonds Accrued Outstanding Interest First mortgage 5% bonds. $2,000,000.00 $8,333.34 First and refunding 6% bonds 4,000,000.00 20,000.00 $6,000,000.00 $28,333.34 When several series of bonds are outstanding, it may be advisable to open an interest account for each series, as "Accrued Interest on Bonds Series A," "Accrued Interest on Bonds Series B," etc. Of course, in a bookkeeping system where the Ch. 20] BOND INTEREST 1207 voucher" is in use, a journal voucher would be made out for the above entry, giving full details respecting the interest applica- tions, as "Accrued Interest on First Mortgage 5% Bonds," and "Accrued Interest on First and Refunding 6% Mortgage Bonds." Since the coupons of the first and refunding mortgage 6% bonds are now due, an entry is made setting up the liability for the particular coupon and closing off the portion of interest accrued to date, thus: June 30, 1922 Accrued Interest on Bonds $120,000 To Bond Coupons No. Q. Due July i, 1922 (A Co. 6's) $120,000 For six months' interest due July i, 1922, on $4,000,000 of first and refunding 6% gold bonds. An entry similar to the above is required each time the coupons on any particular bond issue fall due. At the same time a check is issued to the financial agent for redemption of the coupons No. 9 as they mature. The entry is: The Globe Trust Company, Trustee $120,000 To Audited Vouchers (or Cash) $120,000 For payment of six months' interest due July i, 1922, on $4,000,000, etc. It will be seen now that all No. 9 coupons are standing on the ledger as a liability and so remain until paid, no matter how long that may be; also that there is a corresponding charge to the trustee for an equivalent amount. The trustee renders a report at the end of each month, setting forth the amount and number of coupons paid to date, all of which are turned over to the company for cancellation. At that time an entry is made for as many coupons as may have been paid. For illustration we will assume that $84,800 of the above amount has been presented and paid, requiring this entry: July 31, 1922 Bond Coupons No. 9, Due 7/1/22 (A Co. 6's) $84,800 To The Globe Trust Company, Trustee $84,800 For interest coupons paid by The Globe Trust Company, Trustee, during the month of July, 1922, per statement rendered. 1208 CORPORATE ACCOUNTING [Bk. III- If more than one class of coupons were paid, the others would be entered in like manner. For the first mortgage 5% bonds, similar entries are required at the end of September. At the end of the fiscal year or half-year, the account for the interest on bonds must of course be closed into Profit and Loss. At that time Bond Interest accounts for any and all issues or series, whether accrued for the full year, or only for one month, must be closed off. 194. Interest on Treasury Bonds Treasury bonds, for the present consideration, are under- stood to comprise the issuing company's own bonds which have been acquired by purchase or donation. This ownership, so long as the bonds have not been canceled, makes no difference in the manner of handling or accruing bond interest payable. The monthly accruals are set up as usual, and the interest check handed over to the paying bank at the proper date, while the bank in turn cashes the bond coupons presented for payment, regardless of ownership or of the sources whence they come. The issuing company, on the other hand, treats the treasury bonds as investments, the same as bonds of other companies, and collects the income therefrom in like manner. In case monthly accruals of $10,000 income from treasury bonds and other investments are required to be set up, an entry should be made at the end of each month about as follows : January 31, 1921 Accrued Income from Investments $10,000 To Income from Investments $10,000 For accrued income on investments for one month, as follows: (Recite the amount, rate, etc.) If it is desired that the income from treasury bonds be kept separate from that of other investments, debit Accrued Income from Treasury Bonds and credit Income from Treasury Bonds. As the cash is received in payment the following cash book entry is required on the due date : Ch. 20] BOND INTEREST 1209 j July i, 1921 Cash $6o,poo To Accrued Income from Investments $60,000 For cash income on investments due today as follows: (Recite details of investments.) At the end of each fiscal period the Income from Investments account is closed to Profit and Loss as follows : December 31, 1921 Income from Investments $120,000 To Profit and Loss (or Income) ' $120,000 To close into Profit and Loss, being total income for the year from investments. 195. Interest on Guaranteed Bonds Interest payments on guaranteed bonds are handled in the same manner as those of any other class of bonds. The issuing company pays the interest in the usual way if it is able. In case it is unable to do so, the guaranteeing company must make the payment, which must obviously be considered an advance to the subsidiary company, to be repaid at some future date. At the time ot the advance, a cash book entry should be made as follows : Advances to Subsidiary Company (giving name of company) . . . $25,000 To Cash .., . f j. $25,000 For payment of interest due this day on $1,000,000 of guar- anteed 5% bonds of The Company. On the books of the issuing company the following entry is required : Bond Interest (or Bond Interest Accrued) $25,000 To Advances from . lU)p. JJl' Company $25,000 (Full explanation here.) The entries may of course be very different from those shown, depending upon the agreement existing between the two companies; but in any case the matter should be clearly set forth in each company's books so as to show the amounts respec- tively payable and receivable. 1 2 10 CORPORATE ACCOUNTING [Bk. III- 196. Interest on Income Bonds 2 Since income bonds are to all intents and purposes the same as preferred stock, it is manifest that the book entries for the interest thereon would be practically the same as those required for dividends when declared. As in the case of stock, interest on income bonds can be paid only when the company's profits are sufficient to justify such payment; therefore, as a rule no entry is necessary or advisable until the directors decide whether or not it shall be paid. On the other hand, when it is practically assured that the interest coupons will be paid, monthly entries for accruing interest are in order. Income bonds generally contain half-yearly coupons, though their payment, of course, is con- tingent upon the company's earnings. When declared at the interest date the following entry is made : December 31, 1921 Interest on Income Bonds $25,000 To Interest Payable on Income Bonds $25,000 For interest at 5% on income bonds for six months, declared by the Directors and payable January i, 1922. The Interest account is closed into Profit and Loss. When the interest is paid, the cash entry should be as follows : January i, 1922 Interest Payable on Income Bonds $25,000 To Cash $25,000 For payment of interest on income bonds. 197. Interest on Special Bond Issues The principles already stated for the entry of bond interest apply in handling the interest on all other bond issues where registered and coupon bonds are used, whether secured or other- wise. Profit-sharing or participating bonds require extra entries for setting aside the share of profits apportioned to them, which in turn would be paid by check or otherwise, as the case might be. 1 See Book II, { go. Ch. 20] BOND INTEREST 12 1 1 198. Interest Charged to Construction The Interstate Commerce Commission and the various state public utility commissions permit the capitalization of various charges during periods of construction. This principle might apply equally well to corporations not under commission regu- lation, so long as the charges capitalized are actual and legi- timate and expended during the construction of plant, or ex- tension of property and equipment. Real estate development companies and other similar enterprises generally include certain "loading" charges as part of the development or construction cost. Such charges may include development expenses, interest on bonds and loans, legal and other direct expenditures, bond discount, etc. These items are usually charged to the appro- priate accounts; and then at the end of the year, or upon com- pletion of the construction, a transfer entry is made to place them in the Construction account or to such other account as may be proper. The following entry shows the manner in which such transfers should be made: December 31, 1921 Construction Account $42,000 To Construction Expenses $20,000 Bond Interest 10,000 Loan Interest . 4,000 Bond Discount 8,000 To close above accounts into Construction account, being all of the construction expenses and interest, and the pro- portionate amount of the bond discount for the period. Many corporation officials advocate the addition of all bond discount and expense to plant account if the bond issue was created for the purpose of extending the plant; but this practice is objected to on the ground that the manufacturing account through depreciation charges would eventually be made to bear a considerable portion of the expense of financing the company. 121 2 CORPORATE ACCOUNTING [Bk. III- 199. Income from Investments Income from investments other than treasury bonds is handled in the same manner. If income is derived from several disconnected investments, it is advisable to open separate accounts to distinguish the sources, as Income from Bonds, In- come from Real Estate Investments, Income from Dividends, etc. Dividends from stock investments, however, should not be entered as accrued monthly income, or entered in any other way until the dividend has actually been declared. 3 A plan of entering income from investments that differs slightly is given below. Assume that Company A owns $1,000,- ooo of Company B's 6% bonds, payable January i and July i. At the end of each month the following entry should be made on Company A's books for the accrued income : January 31, 1922 Accrued Interest on Bonds Owned $5,000 To Interest on Bonds Owned $5,000 (Full explanation here.) At the regular interest dates, July i and January i, or in fact the day preceding, the following entry should be made : June 30, 1922 Company B $30,000 To Accrued Interest on Bonds Owned $30,000 (Full explanation here.) When the bond coupons are presented to the paying bank and the cash received therefor, the following entry is required : July i, 1922 Cash $30,000 To Company B $30,000 (Full explanation here.) It is apparent, of course, that this could be handled in other ways. The precise method is immaterial so long as it records the matter adequately and clearly. See f 132. CHAPTER XXI BOND DISCOUNT AND PREMIUM 200. Adjustment of Accrued Interest in Selling Price When bonds are sold at other than the regular interest dates, allowances must of course be made for accrued interest in deter- mining the price actually received for the bonds. For instance, a bond bearing interest at the rate of 6% per annum, payable semiannually, January i and July i, must receive its 3% on the interest date regardless of when it was sold. If, then, such a bond were sold March i, interest has accrued to the amount of i%, and this must be deducted from the amount received to determine the real price of the bond. If the amount received for the bond were 103, it is obvious that i% on the face of the bond must be allowed for the accrued interest, and this being deducted leaves 102 as the price actually received for the bond. If the bond were sold for 100, there would obviously be a dis- count of i% on the transaction, the actual price being 99. 201. Expenses of Bond Issue Many authorities consider the expenses incurred in the floating of a bond issue as directly chargeable to the cost of the issue, in the same manner as discount on the bonds. The Public Service Commission of the First District of New York includes among such expenses the following: All expenses connected with the issue and sale of evidences of debt, such as fees for drafting mortgages and trust deeds, fees and taxes for recording mortgages and trust deeds, cost of engraving and printing bonds, fees paid trustees provided for in the mortgages and trust deeds, fees and commissions paid underwriters and brokers for marketing such evidences of debt, and other regular expenses. 1213 1 2 14 CORPORATE ACCOUNTING [Bk. III- 202. Entries for Bond Discount and Expense To illustrate the disposition to be made of discount on bonds and the other expense inevitable in connection with a bond issue, we will assume that the bond issue of $1,000,000 of the Lenox Iron Works was sold for cash at 90 flat, and that expenses in- curred in connection with the issue amounted to $5,000. The bond discount may be charged under "Discount on Bonds" or some other suitable title, and the expense, to "Expense of Bond Issue"; or both the discount and expense may be charged to one account, as "Bond Discount and Expense." The entry for the sale is: January i, 1922 Cash $900,000 Bond Discount and Expense 100,000 To Unissued First Mortgage Bonds $i,ooocoo For entire issue of first mortgage 5% bonds sold to bankers at 90. Bond Discount and Expense $5,000 To Cash $5,ooo For bond issue expenses paid in cash. 203. Entries for Bond Premium Premium received on the sale of bonds is credited to a dis- tinguishing account, as "Premium on Bonds," "Bond Premium," or "Premium and Discount on Bonds." Assuming that the issue of $1,000,000 bonds of the Lenox Iron Works sold at a premium of 2%, the following entry would be made : January i, 1922 Cash $1,020,000 To Unissued First Mortgage Bonds $1,000,000 Premium on Bonds 20,000 (Full explanation here.) 204. Nature of Bond Premium and Discount The entries required to bring bond premium or bond discount upon the books are simple. After they are brought upon the books, their proper treatment is a more difficult problem. Ch. 21] BOND DISCOUNT AND PREMIUM 1215 The premium or discount which is either received or given upon the sale of the bonds may be said to represent a deduction from, or an addition to, the nominal rate of interest specified in the bonds. Any corporation of good standing and stability can sell its bonds at par if they bear sufficient interest. The rate which they must bear to sell exactly at par is known as the true or effective rate. If the corporation chooses to sell the bonds at any other rate, they will be sold at a premium or discount as the case may be. This premium or discount is the interest refunded in advance or taken in advance on account of the difference between the effective and nominal rates. 205. Treatment of Bond Premium and Discount Since bond premium or discount is from its very nature a deduction from, or an addition to, the amount of nominal interest paid during the life of the bonds, the premium or dis- count cannot be considered as interest applicable to the year of sale only, but must be spread over the life of the bonds. In order that each accounting period may show accurately the true cost of carrying the issue, the premium or discount must, as stated, be written off over the life of the bonds, and credited or charged periodically to the Interest account and through this to Profit and Loss. By this procedure the interest expense of each period is so increased or decreased that the charge against income for each instalment is for the amount of the interest at the nominal rate plus a part of the discount or minus a part of the premium. This procedure is known as "the amortization of the premium or discount." Some organizations with a large surplus make a practice of writing off the Bond Discount and Expense account immediately, but this does not show the true cost of carrying the issue and is therefore misleading. Other organizations write off the discount in several instalments, but this is not accurate and is as objec- tionable as the practice of charging it off immediately. I2l6 CORPORATE ACCOUNTING [Bk. Ill- Bond premium is, much more frequently than discount, thrown immediately into Profit and Loss or Surplus. This practice is, of course, just as misleading as the same method of handling a discount would be. The objections to charging off the premium or discount im- mediately are that by this practice the true rate of interest paid on loans during their currency is lost sight of, current fixed charges against earnings are understated, and the portion repre- senting the discount or premium is charged against or credited to surplus arising out of previous operations, instead of being charged against or credited to income from current and future operations, to which it applies. The result is that not only cur- rent but future operating statements are distorted during the Hfe of the bonds. C 'ttnl.v'f vt;// ;f> 10 m 206. Principles of Amortization When the discount at which bonds have been sold is to be amortized, a certain part of that discount, as well as the periodi- cal interest instalment, is debited to Interest account as the inter- est is paid or the accrued interest set up. The amount of discount thus charged off is credited to Bond Discount, or Bond Discount and Expense, or whatever the account into which the discount was charged. If the bonds were sold at a premium which is now to be amortized, the amount of the debit to Interest is reduced below the amount actually to be paid, the reduction being the amount of the periodical amortization of premium. This amount is charged to Bond Premium account. The entries required for the handling of bond premium and discount at the dates of sale of the bonds and of periodical interest payments are summarized below. The difficulty in the actual making of the entries arises from problems connected with the computation of the amounts of the periodical charges to Bond Premium or credits to Bond Discount at the inteiest dates. In subsequent sections various methods of amortizing the premium or discount are discussed. Ch. 2i] BOND DISCOUNT AND PREMIUM 1217 207. Entries for Bond Premium and Discount Bonds sold at a discount and redeemable at par: Entry at time of sale: Cash (amount received) Bond Discount (amount of discount) To Bonds (par value of bonds) Entry at time of periodical interest payment: Interest (amount of interest plus proper part of discount to be amortized with this payment) To Bond Discount (proper part of discount to be amortized with this payment) Cash (amount paid) Bonds sold at a premium and redeemable at par: Entry at time of sale; Cash (amount received) To Bond Premium (amount of premium) Bonds (par value of bonds) Entry at time of periodical interest payment: Interest (amount of interest minus proper part of premium to be amortized with this payment) Bond Premium (part qf premium to be amortized at this time) To Cash (amount paid) Bonds issued at par and redeemable at a premium: Entry at time of sale: Cash (amount received) To Bonds (par value of bonds) Entry at time of periodical interest payment: Interest (amount of interest plus proper part of premium to be amortized with this payment) To Bond Premium (proper part of premium to be amortized with this payment) Cash (amount paid) Bonds sold at a discount and redeemable at a premium : Entry at time of sale: Cash (amount received) Bond Premium and Discount (amount of discount) To Bonds (par value of bonds) I2i8 CORPORATE ACCOUNTING [Bk. III- Entry at time of periodical interest payment: Interest (amount of interest plus proper part of discount given at time of sale and of premium to be paid at time of redemption) To Bond Premium and Discount (proper part of discount given at time of sale and of premium to be paid at time of redemption) Cash (amount paid) This periodical credit to Bond Premium and Discount will gradually convert the debit balance of that account into a credit which will eventually become sufficient to equal the amount of all premiums payable on final redemption. If it is desired to accrue the interest and the amortization of premium or discount monthly or at any other dates than those of the periodical interest payments, the entries given above as being applicable at the dates of the interest payments would be used with the exception that instead of the credits to Cash the entries would show credits to Accrued Interest on Bonds for the amount accrued. The payments of the interest would then be shown by the following entry : Accrued Interest on Bonds To Cash The only problem in making the above entries arises in deter- mining the amount of the proper part of the premium or dis- count to be amortized with each payment of interest, or, in other words, is found in the computing of the amount of the periodical charge to Interest account. The various methods in use for de- termining this amount are discussed in the following sections. 208. Effective Rate Method The best modern practice for amortizing either bond premium or discount is known as the "effective rate method." Under this plan there is taken as a charge against profits of each year the effective interest rate calculated from the known conditions of issue upon the whole amount outstanding during the year. As- Ch. 21] BOND DISCOUNT AND PREMIUM 1219 certaining the effective rate is, however, a rather difficult prob- lem in actuarial science, the discussion of which would be far beyond the scope of this work.i Because of its complexity the effective rate method, while undoubtedly the most scientific, is not so common as are some of the other methods discussed below. The bonds outstanding method, presented later in the chapter, gives results so close to those achieved by the effective rate method that it is considered almost as satisfactory, and is much more generally used because of the greater ease of computation. In cases, however, where the highest accuracy is desired for any reason, and it is thought best to make the calculations as exact as possible, the effective rate method is preferable. 209. Equal Instalment Method A method more common than the effective rate method and easier of computation, is to ignore altogether the effective inter- est rate, charging against the profits of each year the interest actually paid plus a proportionate part, according to the whole term of issue, of the discount on issue or premium on redemption, or minus a proportionate part of the premium received at the time of issue. To illustrate the handling of premium or discount accounts on the books under this method, let us assume that the $i,- 000,000 issue of the Lenox Iron Works which sold at 90 flat, and the expenses of which were $5,000, runs for 20 years and bears interest at the rate of 5% per annum, payable annually. The total of the Bond Discount and Expense account shows $105,000 that must be written off over the life of the bonds. In addition to interest at the rate of 5%, or $50,000, which the issue carries, the Interest account must be charged each year with one- twentieth of the discount and expense of $105,000, or $5,250, making the total charge against income $55,250. At the end of 1 Reader? desiring to go into this field are referred to Sprague and Perrine on The Account, of Invest.; Walton and Finney on Math, of Acctg. & Finance. 1220 CORPORATE ACCOUNTING [Bk. III- the first year, if monthly entries are not made, the entries re- cording this would be : Interest on Bonds i .; W; . U'. :>f j $50,000 To Accrued Interest on Bonds ,. , r i{.f;/y. .(.><>{! j^rti $50,000 Interest accrued on the issue of $1,000,000 first mortgage 5% bonds. Interest on Bonds $5,250 To Bond Discount and Expense ,- f . $5.250 Difference between the nominal and true effective rates on the $1,000,000 bond issue. Accrued Interest on Bonds. . ,/j .^j| n .,. $50,000 To Cash ..,...,..:_.. ri . " $50,000 Payment on accrued interest on $1,000,000 bond issue. The interest is eventually closed into Profit and Loss by the following entry : Profit and Loss $55,250 To Interest on Bonds $55,250 Transfer of the interest on $1,000,000 bond issue to Profit and Loss. The entries for bond premium would of course be of the same general nature. The equal instalment method has a wide popularity because of its simplicity, but there are those who object to it on the ground that it is unscientific. In view, however, of its frequent use, the objection might be considered a purely academic one. Yet it is not as satisfacotry as the bonds outstanding method. 210. Bonds Outstanding Method A third method is to distribute the discount or premium over the period in the proportion that the bonds outstanding for each year bear to the sum of the bonds outstanding for all years of the currency of the loan. "The charge to Income account on the bonds outstanding method is arrived at as shown in the following table. It is so close to that given by the effective interest method that for all practical purposes it may safely be adopted." Ch. 21] BOND DISCOUNT AND PREMIUM 1221 Period HYea Bonds r Outstanding Proportion of Out- standing Bonds to Total Bonds Amount of Discount Instalment Interest Payment Profit on Bond Purchase Annual charge to Profit and Loss I 2 3 $ 1,000,000 950,000 900,000 TOO AOSO 95 A50 90 AOSO $ 1 1 ,905 11,310 10,714 $ 25,000 23,750 22,500 $ 4,000 4.OOO 3,500 $32,905 31,060 29,714 4 5 850,000 800,000 80 A 05 10,119 9,524 21,250 2O,OOO 3,500 2,500 27,869 27,024 6 7 750,000 7OO,OOO 75 A50 70 AOSO 8,929 8,333 18,750 17,500 2,500 I,50 25,179 24,333 8 9 650,000 6oo,OOO 65 A5 60 A 5 7,738 7,143 16,250 15,000 1,500 I.OOO 22,488 21,143 10 ii 550,000 500,000 55 A5 50 AOSO 6,548 5,952 13,750 12,500 1,000 2,500 19,298 15,952 12 450,000 45 A 5 5,357 11,250 2,500 14,107 13 400,000 40 A 050 4,762 IOOOO 1,500 13,262 14 350,000 35 /ioso 4,167 8750 1,500 11,417 15 300,000 30 A5 3,57! 7,500 500 10,571 16 17 250,000 2OO,OOO 25 A5 20 A O 5 2,976 2,381 6,250 5,000 500 8,726 18 150,000 I "J/IO1O 1,786 7,71:0 5,536 IOO,OOO IO /lO'JO I.IQO 2,500 20 50,000 595 1,250 1,845 $10,500,000 $125,000 $262,500 $34,000 $353,500 2 211. Complications Introduced by Market Conditions Bonds for sinking fund purposes are often purchased in the market at prices varying from, and generally less than, the specified redemption prices, and are then transferred to the trustees of the sinking fund at the specified prices. A saving is thus effected which must be taken into account when determin- ing the annual charge against income. This saving may best be dealt with by closing such gains to Profit and Loss each year, thus finally disposing of them. This method is not theoretically accurate, but theoretical accuracy is impossible in view of the impossibility of determining what the market price will be in the future. By permission, from Acctg. Prac. & Proc.. by A. Lowes Dickinson, p. 141. 1222 CORPORATE ACCOUNTING [Bk. III- It will be seen that the equal instalment method discussed earlier in the chapter is inadequate in such cases as this. 212. Anticipation of Redemption Dates 3 Further disturbing factors in accounting for bond redemp- tion may be introduced by anticipating the redemption dates for a whole or part of the issue. The treatment of such cases is a more difficult matter, for, if carried out on a fairly large scale and not accompanied by an equitable reduction on the redemp- tion price, the true interest rate will be materially increased. Under such conditions the equal instalment method will be seen to be unsound. If the effective rate method is used, it will be necessary ... to recalculate the effective rate on the basis of the bonds still outstanding and the new redemption terms. If this is not done, there may be a considerable shortage to make up at the date of final redemption. This fact is frequently overlooked, although it should be recognized as an important factor, particularly in any refunding or redemption plan. . . . For instance, if the conditions of the issue provided that $100,000 of bonds be retired during the year at 105, and as a matter of fact they are purchased at 95, the true interest on the bonds bearing interest during the year would be reduced by $10,000, representing the saving on bonds retired during the year as com- pared with the price therefor assumed in determining the effective rate. The tendency of this method would probably be to increase gradually the annual charge to Income for interest and sinking fund until the limit price of redemption was reached; for, as the amount of the bonds outstanding diminished, the market price might be expected to rise. 213. Operation of the Various Methods In order to show the effect of these various methods, it may be well to consider a specific case as follows: An issue of $1,000,000 of bonds is made at 90, carrying interest at 5%, and redeemable at the rate of $50,000 each half year, at 100 1 Quotations in this and the following section and the table given at the end of the chapter are taken by permission from Acctg. Prac. & Proc., by A. Lowes Dickinson, pp. 136-140. Ch. 21] BOND DISCOUNT AND PREMIUM 1223 r . 888888888888:88888888 Charge to Income oogoQddddddoodQdQOdO when Discount 5>n5i/vO^o>og i nQinoinQioO l o5"; ; charged to Profit q. ^ _ ^ "2 i - ^ "^ - ^ "3 CN l - ^ - ^ "^ - and Loss Ac- ~ ON CM-* rxO O * TT 01 O 00 OO count ^r ^ OOOOOOOOOOOOOOOOOOOO Charge to Income . . . . en Discount o o >-< \X 04 t^ cooo T)-"S in O o "- 1 f~oioo written ort on o 5 t^oo O *-< co^>-i 01 C) | - < _oi ^"^tx Bonds outstand- of >-T oi r^ K! in rf of i-T o^ yj> "^F co |-|" O O0~ ** "^ <*> method ff ^ ^ char ge to income 08888888888888^8 on equal annual Instalment Method t>O ip Tf ro oi of M Charge to Income co ^ O> K in o[ Q cc on effective in- terest method . ^- _,- d^Kvo 10 ^f of M" c?i "^ ^ co' " o"oo" ^? ^ 8Q9OQQOQQQQQ qqqqqqqqqqq 8'ddddddddQd 5 5 5 5 q $ Q q q q redemption price -^ rf co co of of w" w" M~ -i oi oi M & ID\O qo c\ o w co TJ- yo\o ?Q S> O r^ i-O ^3 I-H o CO ^O Discount provided co ,< o o^vg ^ tx ^> co d g O ^ N d O tor \6) \i) QQ c\( \Q o ^i"00 01 o | t >o C^ co rx *- in o^ co t^ >-* f M i-T o" o d\oc"oo" tC r-Cvo" ininrF^fcoofofi-ri-r M 10 o" l_ _ M _ CS W- jno^oo OQJH COT)- 100 05. o^q 01 EfTective Interest ro d^K-iooi dodsd ^t 1 -" oSS.mcod rharijf" at 8 1/16%, ^rO .coOi/"i"-iO OI rge at o o/ 10 ) og 5 M ro TO ?> ON ^ ^N * m t^ 1 *, O 01 co in * ~ in co of cfoc o T? oi H-( d^ t^* in co "- 1 5OQOOQQOQ5Q5OQQQQ55Q qqqqqqqqqqqqqqqqqoq terest at5%D SOOddddddOQOdOcdQOQO LCICSI 0.1 j iv v q ir> c m 5 ir/ 5 m 5 m O m q m c u~, o m O m a. (a) o t*x in 01 5 tx in ^j o r^ m 01 5 ^^ *n oi in co of h-T p'oo" txo* in co of ^ o'oo txo" in co oi M~ t *" 5 Period V* Year M d o ^j- u^O tvOO O\ O w oj co ^r mo txoo O> _ ~*|HMMMM^U 1224 CORPORATE ACCOUNTING [Bk. III- for the first five years, and thereafter at 105. Calculations made on these premises show that the effective rate of interest is approxi- mately 83/16%. Bondsare redeemed each as specified, but they are purchased in the market at the following prices, viz. : ist year 92 2nd year 93 3rd year 95 4th year ' 97 5th year 98 6th year 100 7th year 102 8th year 104 9th and loth drawn at 105 The table on page 1223 gives all the essential figures. In the table on the preceding page, the last four columns show the charges to Income account on the basis (5) of the effective interest method; (6) of the equal instalment method; (7) of the bonds outstanding method; and (8) of charging all discount and premium to surplus; in each case crediting to Income account the surplus arising from purchasing bonds at less than the fixed redemp- tion price. If the latter be credited direct to surplus, or carried in the Bond Discount account until all discount has been written off by the operation of these credits and the balance of the effective rate, then, at the end of the nth half year in the first case and at the end of the isth half year in the second, the discount will be extinguished and thereafter only the actual interest paid, less surplus on market purchases, will be charged to Income. CHAPTER XXII PRINCIPLES OF FUND ACCOUNTING 214. Nature of Funds A fund is normally represented by a debit balance. It is a reservation of assets set aside periodically for a specified purpose and usually placed in the hands of a trustee for safe-keeping until the date arrives for their expenditure in accordance with the purpose for which the fund was created. While funds are usually composed originally of cash, this cash may be invested in order that an income may be produced therefrom. In such cases the assets thus purchased compose their part of the fund. Funds are resorted to as a convenient method of accumulating money for various purposes, and are established in two broad general classes, i.e., those from which the income only is to be used, the principal being maintained intact, and those which are so constituted that both principal and income are to be used for the desired purpose. The best examples of the first classification are the endowment funds of educational institutions and the trusts created by will or otherwise. The use of the income from such funds may be limited to specific purposes, but the usual use of the income from endowment funds is for the payment of current expenses. Funds established with the intention of using both the prin- cipal and income are accumulated for many purposes, as for example, the cancellation of a lease, the acquirement of addi- tional machinery or new buildings, the securing of a new mine or other wasting asset when that which is now owned is exhausted, the retirement of a bond issue or of preferred stock, or simply in order to be able to meet promptly and without embarrassment any extraordinary loss or expense which certain businesses are 1225 1226 CORPORATE ACCOUNTING [Bk. Ill- liable to suffer without notice. The names given such funds are usually descriptive of their purposes, as, for example, New Machinery Fund, Factory Building Fund, Bond Sinking Fund, Bond Retirement Fund, Preferred Stock Redemption Fund, Emergency Fund, etc. When the fund is used in connection with the depletion of mines or other wasting assets, it is fre- quently called an "Extinguishment Fund." 215. Confusion between ' 'Reserve" and "Fund" There can be little excuse for a confusion which exists between the uses of the words "fund" and "reserve." The fund is an asset; the reserve is a credit item representing either a deduction from an asset valuation (as in the case of Reserve for Deprecia- tion and Reserve for Losses from Uncollectible Accounts) or an appropriation of surplus. The reserve account shows a credit balance, while the fund shows a debit balance. A fund is created by the reservation of cash, or by the in- vestment of cash in securities, the cash or securities being held for a specific purpose. When this purpose is the redemption of bonds or the replacement of a wasting asset, the result is a sinking fund, redemption fund, or replacement fund, as the case may be. If, however, a reserve is created for the redemp- tion of bonds by a charge against Surplus, but no actual reserva- tion of cash or other property is made, the result is a reserve but there is no corresponding fund. In the one case the actual cash is withdrawn and held, and it, or its equivalent if it is invested, is there for the redemption of the bonds as they fall due. In the other case, the profits have merely been withdrawn from Surplus, so that they cannot be declared in dividends or diverted to other uses. This is all the reserve does, and the directors must take such steps as may be necessary to secure cash to pay the bonds when they fall due. Sufficient cash may perhaps be in the treasury for the purpose, but in the case of a large amount of bonds or an entire issue falling due, this is seldom the case; as a re'sult cash must be borrowed Ch. 22] PRINCIPLES OF FUND ACCOUNTING 1227 or be secured by the sale of some of the company's property to meet redemptive needs. For this reason, to provide for the re- demption of bonds or the liquidation of any heavy obligation, the fund, or both fund and reserve, are customary. The vital point is that the appropriation of profits by estab- lishing a reserve and rendering the profits unavailable for divi- dends is one thing; the actual placing of cash or other assets in a fund is a different thing. Either the fund or the reserve can exist independent of the other. The reserve has no specific function to perform beyond the mere safeguarding of the profits. 1 216. Contract Requirements for Funds and Reserves Deeds of trust frequently provide that reserves for the redemption of bonds "shall be created out of profits." Bonds may be refunded, but if they are to be paid off without the acquirement of additional liability, it must usually be out of profits or the proceeds of the sale of capital assets. While it is argued that there is no more need of reserving profits for the redemption of bonds than for the reservation of profits for the payment of promissory notes or ordinary bank loans, the con- tract provision has merit as the bond issues are usually much larger in amount than current borrowings and the reserve has a tendency to prevent directors from paying dividends that might so deplete the company's quick assets as to make the payment of the bonds, when due, difficult if not impossible. 2 When a reserve for redemption of bonds is established, there is also usually a setting aside of an equal amount of actual cash in a fund. A reserve for redemption of a bond issue is set aside out of profits by means of a debit to Surplus and a credit to Sinking Fund Reserve, or to Bond Extension Reserve, or to Debt Extinguishment Reserve. If the bonds are redeemed without the issuance of new bonds, the reserve for redemption remains 1 Cf. Ch. Ill, "Reserve Accounts." 'See Book II, Ch. XI, "Redemption of Bonds Sinking Funds." 1228 CORPORATE ACCOUNTING [Bk. III- on the books unaffected by the retirement of the bonds and must be closed into Surplus. This results in a sudden and substantial increase of profits available for dividends, and the directors may then properly "cut a melon" if they see fit. 217. Funds for Redemption Purposes The most common use of the fund in corporation affairs is for the redemption of bond issues and the retirement of pre- ferred stock. The name "sinking fund" is often improperly applied to all such funds. Speaking accurately, A sinking fund consists of assets, usually in the form of cash or securities, set apart to accumulate at compound interest, and dedicated to the purpose of paying at its maturity a debt now owing or certain to be incurred. Unless a fund fulfils all of the conditions of this definition it is not a true sinking fund. The accumulation of compound interest is indispensable. While it is true that a liability due in ten years could be provided for by putting one-tenth of the total amount necessary into a fund each year, such a financial arrangement would not be a sinking fund. The interest under such conditions would not have to be added to the fund because the ten equal annual contributions would provide for the payment of the liability. The proper name for such a fund would be Bond Redemption Fund A true sinking fund must be established for the payment of a positive liability, certain to mature. If the fund is to be used to acquire an asset it is not a sinking fund from the accountant's standpoint. From the mathematical standpoint any fund ac- cumulating at compound interest is a sinking fund, but as used in accountancy it is intended to pay a debt. Moreover, this debt must be certain to mature; if the fund is provided to meet a contin- gent liability it may never be required. Hence it is a contingent fund and not a sinking fund. If the intended use is the redemption of preferred stock, the term sinking fund cannot properly be applied because stock has no definite maturity; the corporation cannot enter into an unconditional contract to redeem its stock at a definite date. Payment of the liability at its maturity is another essential to the definition. If a fund is established to pay off a bond issue, the Ch. 22] PRINCIPLES OF FUND ACCOUNTING bonds must be retired and canceled at maturity and not before. Thus, if a company provides a fund to liquidate its bonded debt, it may cancel the entire indebtedness at maturity, or cancel por- tions thereof at various times. But if it chooses the latter pro- cedure, the fund is a redemption fund and not a sinking fund. This does not mean that the company accumulating a sinking fund cannot buy up year by year, the very bonds which the fund is intended to retire. But if this is done, such bonds must be held alive. That is, they must be included in the liabilities instead of canceled, and they must be carried as part of the fund. 3 218. Sinking Fund Account Credit: With amounts of money disbursed for the purpose for which the special fund was created. Debit: With the value of assets transferred from the general funds of the business to a special fund for the specific purpose of creating or increasing a sinking fund to meet some fixed obligation at a particular time, as a bond issue, mortgage, or other debt. With the income derived from the investments of money set aside as a sinking fund. (At this time credit Sinking Fund Income account.) The balance of this account is an asset and should at any time represent the accumulated value of the sinking fund. The moneys thus taken are usually handed over to a trustee or board of trustees for safe-keeping and investment, the duties of such trustee in respect of such funds being set forth in the document creating the trust. The handling of other funds on the books of account is the same as that of the sinking fund. For the account with the fund, as given above, there are frequently substituted in the case of either sinking or other kinds of funds several accounts descriptive of the form in which the assets are held, as Sinking Fund Cash, Sinking Fund Invest- Adv. Acctg., by Seymour Walton, p. A?73. 1230 CORPORATE ACCOUNTING [Bk. III- ments, etc. The Sinking Fund Cash account would be debited with money transferred to the fund, with receipts of income, and with the proceeds of the sale of sinking fund investments. It would be credited with cash spent or invested. The Sinking Fund Investments account would be debited with the value of assets transferred and the cost of assets purchased, and would be credited with any sales of investments, the amount of the credit being the figure at which the assets sold were originally charged to the account. The amount of any loss would be debited to Sinking Fund Expense; that of any profit would be credited to Sinking Fund Income. 219. Sinking Fund Income Account Debit: At each periodical closing of the books this account is debited with the balance remaining in it, the corresponding credit being to Profit and Loss or to Sinking Fund Reserve account. Credit: With any income in the shape of interest or dividends received from in- vestment or deposit of sinking fund moneys, as reported by the sinking fund committee or trustee in charge of the sinking fund. Income from sinking fund moneys, whether invested in securities or on deposit in the savings bank, is a profit to the corporation, and is usually credited to some representative ac- count, as Sinking Fund Income, or Interest on Sinking Fund. As illustrated in the next chapter, this account is in turn closed into Profit and Loss, or Reserve for Sinking Fund in case the latter account is being carried. o/lJ .- 220. Sinking Fund Expense Account Debit: With the amount of expenses incurred in operating the fund, such as trustees' and brokers' commissions, etc., and with the amount of loss on the sale of fund investments. Credit: At each periodical closing of the books this account is credited with the balance remaining in it, the correspond- ing debit being to Profit and Loss or to Sinking Fund Reserve. Ch. 22] PRINCIPLES OF FUND ACCOUNTING 1231 The general principles underlying the handling of the Sinking Fund Income account apply equally, but in reverse, in the case of the Sinking Fund Expense account. 221. Summary of Sinking Fund Principles The sinking fund, as already stated, is made up of periodical cash payments to the trustee and the interest accumulations; therefore, definite book entries are required at regular periods to record properly the instalments and interest accretions. An account must be opened for the sinking fund, or for the sinking fund trustee, to which shall be debited the various payments and accumulations, with corresponding credits to Cash and to Sinking Fund Income. If the trust agreement requires that the sinking fund shall be created out of profits, then an annual reserve equivalent to the sinking fund instalment must be set aside. The fund itself, however, is composed of assets and recorded on the debit side of the ledger, while the Sinking Fund Reserve account is a credit and shown on the credit side. Careful book records must of course be kept of all details respecting the sinking fund and any reserves required in connection therewith. In the case of small companies the sinking fund procedure is often much less formal than in the case of larger companies, and it is not unusual for the whole of the funds to remain in the hands of the directors themselves; but in any case the accounts should be so kept as to show all information that may be required by any of the interested parties respecting the bonds and the sinking funds. The regulations of the Interstate Commerce Commission provide for sinking fund accounts of railroads, and quotations from these may be of interest to other than railroad accountants. The first quotation prescribes what shall be included in the sinking fund: This account shall include the amount of cash, the ledger value of live securities of other companies, and other assets which are 1232 CORPORATE ACCOUNTING [Bk. Ill- held by the trustees of sinking and other funds for the purpose of redeeming outstanding obligations, including such assets so held in the hands of the accounting company's treasurer when the assets are segregated under a distinct fund ; also amounts deposited with such trustees on account of mortgaged property sold, the proceeds of which are to be held for the redemption of securities, and the par value of live securities issued or assumed by the accounting com- pany and held in such funds. A separate account shall be kept for each fund. The title of each such account shall designate the obligation in support of which the fund is created. Railway companies not infrequently create sinking fund reserves also, which of course must be set aside out of profits. The Commission's ruling on the subject of the Sinking Fund Reserve account is as follows: This account shall include the net balances in accounts to which are credited definite appropriations of income and surplus, whether held in general funds or specifically set aside in the hands of a trustee for sinking and redemption funds. It shall also include income accretions to such funds retained therein. Income from sinking fund assets is required to be cared for under "Income from Sinking and Other Reserve Funds." To this account are to be credited income accrued on cash securities and other assets belonging to sinking and other reserve funds, such income being included under non-operating income in the company's regular income statement. In case a Sinking Fund Reserve account is maintained, a definite amount must be set aside out of income by a debit to the account "Surplus Applied to Sinking and Other Reserve Funds" and a credit to "Sinking Fund Reserves." Such amounts are generally set up monthly, but at the end of each year "Surplus Applied to Sinking and Other Reserve Funds" account must necessarily be closed out. 222. Adequacy of the Sinking Fund It will readily be seen that the amount of the sinking fund deposits must be calculated in advance, so that when the bonds mature there will be sufficient cash available for their redemption. Ch. 22] PRINCIPLES OF FUND ACCOUNTING 1233 In case of shortage for any cause, additional funds must be raised to pay off the maturing bonds. On the other hand, if the required amount has been accumulated prior to the date of maturity, further sinking fund payments may be discontinued unless otherwise provided in the agreement under which the sinking fund is created. Where definite amounts are set aside yearly, such amounts are generally governed by the aggregate debt outstanding, and by the estimated rate of interest the fund is likely to earn. For example, if it is desired to meet a debt of $800,000 in 20 years, an annual deposit of $26,866 to the sinking fund would, at 4% interest compounded annually, provide an adequate cash supply for the purpose, but this presupposes that the trustee will be able to keep the funds continuously invested at this rate. This may not always be possible, and on the other hand it is probable that the trustee may be able to secure a better interest rate, particularly if he is permitted to invest in the company's own bonds. It will be seen, then, that the exact earning capacity of trust funds cannot be accurately foretold, and that officials should be governed accordingly in determining the sinking fund instalments. 223. Annuity Method for Sinking Funds There is a growing tendency to apply scientific annuity cal- culations to bonds and sinking funds, as well as to amortizing diminishing balances. Under this plan it is assumed that all instalments and interest accumulations to the sinking fund will earn compound interest from year to year, at a given rate, say 3% or 4%. The amount that shall be in the fund at any time is carefully estimated when the bonds are issued, so that at the date of maturity there may be in the hands of the trustee enough to pay the debt. If at any time this estimate falls short, because of a lower earning rate or for any other reason, an adjustment must be made by increasing the annuity or by making a special deposit equal to the existing deficit. When estimating the rate 1234 CORPORATE ACCOUNTING [Bk. III- of yield, care must be taken not to use a higher rate than the regular savings bank interest. If, however, the sinking fund trustee invests in the company's own bonds at any time, the income will be materially increased. 224. Calculating Fund Annuities Annuity calculations may be largely avoided by the use of annuity tables, but, notwithstanding this, it is most desirable to Jiave at least a working knowledge of their principles. An annuity is a definite sum of money paid at regular inter- vals. For example, an investment of $>i at 6% per annum, compounded annually, amounts in 5 ' years to approximately $1.33822558. In other words, if the original $i were left on deposit hi some one bank for 5 years, and the annual interest of 6 cents withdrawn each year and deposited in another bank at 6% compounded annually, at the end of 5 years there would be the original $i in the first bank and $.33822558 in the second bank. This latter amount is the result of an annual deposit of 6 cents for a period of 5 years with the interest accumulations; therefore, $.33822558 is the value at maturity of an annuity of 6 cents for 5 years at 6%. From this the final value of any annuity at 6% for 5 years may readily be found, by dividing $.33822558 by 6 to find the value of an annuity of i cent, and multiplying this by the number of cents in the actual annu- ity. Thus, an annuity of $i for 5 years has a final value of Tp- X ioo, which equals $5.637093. This plan requires 6 the use of only the ordinary compound interest tables. To find the final value of an annuity for a given time at a given rate, first multiply the compound interest on $i for the given time at the given rate by ioo, and divide by the given rate. This gives the final value of an annuity of $i. Then the final value of the given annuity is found by multiplying the final value of an annuity of $i by the number of dollars hi the given annuity. Ch. 22] PRINCIPLES OF FUND ACCOUNTING 1235 225. Application of Method The following example will illustrate more fully the applica- tion of the compound interest method to sinking fund accumu- lations: The Consumers' Gas Company on January i, 1922, issued $2,000,000 of first mortgage 5% sinking fund gold bonds, pay- able in 25 years, interest payable semiannually. In order to meet the bonds at maturity, such annual sum in cash is to be deposited with a designated trust company as will accumulate, at 4% compound interest during the currency of the obligations, to an amount sufficient to redeem the bonds. In finding the amount of the yearly annuity payment, we need not consider discount if the bonds should be sold at less than par, nor the expenses of the issue, nor the payment of inter- est coupons. Bond discount and expense are treated as expense .incident to the issue, and as the coupons mature they are paid out of current funds, and the amount charged to Bond Interest, which in turn is closed into the Profit and Loss account. We have therefore to provide only for the payment of the .principal sum of $2,000,000 at the end of the 25th year. We find usually by consulting an annuity table that $i invested annually at 4% compound interest, will amount to $41.64590829 at the end of 25 years. If $i invested annually for 25 years at 4% compound interest will amount to $41.64590829, then by dividing this value into $2,000,000 the amount to be accumulated the quotient is the number of dollars which must be invested each year to amount in 25 years, at 4% compound interest, to the desired sum. Carrying out this division we find the required annuity payment to be $48,023.93. In ascertaining the amount of a sinking fund annuity, the determining factors are the principal to be accumulated, the tune to run, and the rate of interest obtainable. CHAPTER XXIII ENTRY OF FUND TRANSACTIONS 226. The Trustee and the Fund Accounts Sinking funds may or may not be placed in the hands of a trustee, although it is customary except in the case of munici- palities to appoint an independently responsible trustee to take charge of sinking funds required by contract. An officer of the corporation is, however, sometimes appointed in his individual capacity to act as trustee. If the corporation itself maintains the sinking fund without an outside trustee, the transactions in connection with the handling of the fund will usually be recorded on the corporation books as they occur, no independent books of account being kept. If an officer of the corporation acts as trustee, the transactions are usually recorded on the corporation books, although the officer-trustee also frequently keeps an independent set of books for the fund. If there is an independent trustee he (or it, if the trustee is a corporation, such as a trust company) should cer- tainly keep a full record of his handling of the fund. Even in this case the corporation establishing the fund should show on its own books the investment of the fund and the profit there- from, although it must rely on the statements rendered it by the trustee. In this case the entries are made in summary on the corporation books as reports are received from the trustee. The principles laid down in the present chapter for sinking fund entries, when all the transactions are recorded on the books of the corporation, are equally applicable to any other funds which a corporation may establish. Also the method sug- gested for recording the transactions as they occur serves equally well except as noted in connection with the various entries 1236 Ch. 23] ENTRY OF FUND TRANSACTIONS 1237 for putting on the books the transactions of a trustee as these are taken from his reports. 227. Entries for Sinking Fund Instalments The sinking fund instalments are paid in cash to the trustee, either half-yearly or yearly, or even at greater intervals, accord- ing to the requirements of the deed of trust. For illustration, we will assume that the 5% bond issue of the Lenox Iron Works for $1,000,000 required an annual deposit of $50,000 to the sinking fund beginning December 31, 1921. This payment will be recorded : December 31, 1921 Sinking Fund Cash $50,000 To Cash $50,000 First deposit to the sinking fund for redemption of $i,- 000,000 first mortgage 5% bonds due January i, 1941, as required by trust agreement. If there were several bond issues requiring sinking funds, each fund would have a separate account. They should be desig- nated according to the kind and tenor of the bonds, as "Sinking Fund of First Mortgage 5% Bonds of 1925," "Sinking Fund of $4,000,000 First Mortgage 5% Sinking Fund Gold Bonds of 1940," as the case may require. Sometimes the name of the trustee is included in the caption, as "Security Trust Company, Trustee of Sinking Fund," or "Trustee of Sinking Fund of $i,- 000,000 5% Bonds," etc. The title should be sufficiently descrip- tive to indicate clearly the fund and its purpose. 228. Entries for Sinking Fund Interest The duty of the trustee being to safeguard the sinking fund properly and to keep it earning, we will assume in the present in- stance that he deposited the funds in the savings bank to draw 4%. At the end of the first year he must make his report to the company, giving the status of the fund and stating the accumu- lated income thereon, which in this case would be 4% of $50,000, 1238 CORPORATE ACCOUNTING [Bk. III- or $2, ocx). Upon receipt of this report the following entry should be made on the company's books : ' December 31, 1922 Sinking Fund Cash ". $2,000 To Sinking Fund Income $2,000 To record income from sinking fund deposit of $25,000 for one year at 4%, as per report of the trustee. Sinking fund income should be credited to some account that will clearly indicate the sources from which it came, as shown in the above entry. Sinking Fund Income account may be closed at the end of the fiscal period into Profit and Loss, or if there is a Sinking Fund Reserve account, the Sinking Fund Income account may be closed into that. 1 In the former case the entry will be: Sinking Fund Income $2,000 To Profit and Loss $2,000 To close Sinking Fund Income account into Profit and Loss. If there is a Sinking Fund Reserve account, and it is consid- ered desirable to close the Sinking Fund Income account into that, the entry will be: Sinking Fund Income $2,000 To Sinking Fund Reserve $2,000 To close the Sinking Fund Income account into the Sink- ing Fund Reserve. Under the terms of trust under which the sinking fund was established, no mention has been made of the disposition of the income from the fund. It might be handled in any one of three ways, i.e., (i) be turned over to the company, (2) retained by the trustee as an addition to the sinking fund, or (3) be applied to lessening the next sinking fund instalment. Since this is supposed to be a true sinking fund, the income must be added to the principal and draw compound interest. Under this procedure the entries are more involved than in the first or third methods of handling income from funds. Under the Cf. {232. Ch. 23] ENTRY OF FUND TRANSACTIONS 1239 first method the trustee would turn over to the company cash to the amount of the interest or income; and the company, if the entry of Sinking Fund Cash to Sinking Fund Income had already been made, would debit Cash and credit Sinking Fund Cash, but if otherwise would debit Cash and credit Sinking Fund Income. To illustrate monthly entries showing the accrual of the sink- ing fund interest, the following have been constructed upon the facts of the preceding material : Accrued Sinking Fund Income $166.67 To Sinking Fund Income : ,(.J. f<; $166.67 Accrued income at 4% on $50,000 of cash on deposit in savings bank for one month, 1 / a of $2,000. This entry would be made at the end of each month, and at the end of the year the following entry would be made : Sinking Fund Cash $2,000 To Accrued Sinking Fund Income $2,000 Cash collected by sinking fund trustee during the year, being 4% on $50,000 on deposit at the savings bank. 229. Entries for Sinking Fund Investment Instead of depositing the sinking fund cash in the savings bank, the trustee may find it more profitable to invest it, or a portion of it, in gilt-edged bonds paying a higher rate of interest. In some cases he is required to invest the funds in bonds of other companies, or of the issuing company itself. We will assume, therefore, that on January i, 1923, the trustee purchases $100,- ooo of first mortgage 5% bonds of the United States Steel Cor- poration at par, interest due January i and July i. If the trustee of the sinking fund keeps his own books and makes such investments as this independently of the company, the money paid to the trustee will, as shown in the preceding section, be debited to Sinking Fund Cash, and no entry be made on the company's books for the purchase of the United States Steel bonds until the trustee's periodical report is received. The 1240 CORPORATE ACCOUNTING [Bk. III- asset value is continued to be carried in Sinking Fund Cash ac- count until the details of the investment and perhaps of the peri- odical profit therefrom are furnished. In making the investment the trustee is simply replacing a certain amount of cash assets with an equivalent amount of securities, and the company's net worth remains unchanged. But whenever it is possible to record on the company's books all the transactions as they occur, so as to show how the sink- ing fund is invested and the amount of this investment separ- ately from the sinking fund cash, even though the securities are in the hands of the trustee, the following would be the procedure : January i, 1923 Sinking Fund Investments $100,000 To Sinking Fund Cash $100,000 For investment by the trustee in 5% bonds of the United States Steel Corporation at par, as per his report of this day. 230. Income on Sinking Fund Investments The sulking fund now contains bonds which will pay interest twice during the year, $2,500 in cash each six months. If the bonds had been purchased at a premium or discount, another ele- ment would have been introduced that of properly recording such difference. 2 At the end of the first half-year an entry for income would be required as follows: July i, 1923 Sinking Fund Cash $2,500 To Sinking Fund Income $2,500 For coupons collected on $100,000 5% bonds of United States Steel Corporation held in the sinking fund as per report of the trustee. (Full details necessary.) If desired this could be handled by monthly entries accruing the income. At the end of the year, interest will have accumulated on both 'See Ch. XXI, "Bond Discount and Premium." Ch. 23] ENTRY OF FUND TRANSACTIONS 1241 interest and bonds, requiring the following entry on the com- pany's books: December 31, 1923 Sinking Fund Cash $2,630 To Sinking Fund Income $2,630 For interest accumulations to the fund, as per report of the trustee, as follows: Interest at 4% on $2,000 in bank, one year $ 80 Interest at 5% on $100,000 bonds, one half-year. . 2,500 Interest at 4% on $2,500 in bank, one half-year. 50 Total $2,630 Another instalment of $50,000 is due the sinking fund at this time, and is entered as before. 231. Entries for Investment in Issuing Company's Bonds The trust deed in many cases provides for the redemption of the bonds by the sinking fund trustee, either at the market price or at a fixed price, and he is compelled to carry out such pro- visions. In a true sinking fund the bonds so purchased by the trustee will be kept alive as investments of the sinking fund; whereas if the fund is merely a bond redemption fund, the trus- tee will turn the bonds over to the company for cancellation. To exemplify the entries for the purchase of such bonds for sinking fund investment, we will carry the illustration of the Lenox Iron Works a step further, by a purchase on January i, 1924, of $50,000 of the company's own bonds at 102^2. The entry to be made for this transaction must be governed by the circumstances, not because the bonds are those of the issuing company, but because of the disposition to be made of the $1,250 premium paid thereon. The company is the loser of this amount since the bonds are not to be resold, and the premium must be charged off. There is, however, open to the corporation a choice as to whether this premium shall be disposed of at once by a charge to Profit and Loss, or be carried as a deferred expense and amortized over the life of the bonds. 1242 CORPORATE ACCOUNTING [Bk. III- In either case it is the best practice to carry at par the bonds so purchased, charging the premium into an account called "Pre- mium on Own Bonds Held in Sinking Fund," or some other de- scriptive title. The entry at the date of purchase is as follows: January i, 1924 Sinking Fund Investments $50,000 Premium on Sinking Fund Investments ^250 To Sinking Fund Cash $51,250 For purchase of $50,000 of the company's 5% bonds at 102^ by the trustee for sinking fund investment. The Premium on Sinking Fund Investments account will be closed into Profit and Loss, or its amount will be amortized over the remaining life of the bonds by periodical charges to Profit and Loss or to Sinking Fund Income. If the trustee's fund is to be maintained at a definite status at all times, the company may be required to pay over to him additional cash to reimburse him for the amount of the premium payment. Federal income tax laws make this premium an expense of the year in which the corporation's own bonds are repurchased, and do not allow later charges on account of amortization to be taken as a deduction from taxable income in the year in which they are made. For this reason, in order to keep their books in accord with their income tax returns, a great many corporations prefer to charge the premium off immediately. The United States Steel Corporation charges off each year all such premiums (upward of $800,000 or more) on bonds purchased and held by the sinking fund trustee, this item together with the bond inter- est being entered as a deduction from net income. 232. Entries for Sinking Fund Reserve The deed of trust frequently requires an amount equal to the sinking fund instalment to be set aside out of profits.s To carry out this provision a definite amount agreeing with the sinking fund payment must be reserved each period, whether yearly or 'See i 216; also Ch. Ill, "Reserve Accounts." Ch. 23] ENTRY OF FUND TRANSACTIONS 1243 of tener, and credited to a reserve account set up for that purpose. Resorting again to the example under discussion, we will assume that the Lenox Iron Works is required to set aside each year out of profits an amount equal to that of the sinking fund instalments, $50,000 per year. In that event it becomes necessary to with- draw the required amount out of profits by the following entry: December 31, 1921 Profit and Loss or Surplus $50,000 To Sinking Fund Reserve $50,000 To set aside profits equal to the sinking fund deposit for redemption of $1,000,000 first mortgage 5% bonds, in accordance with the trust agreement. Whether or not this reserve shall be kept in harmony with the Sinking Fund account depends upon the trust agreement. In case this is a requirement, it is obvious that every dollar added to the fund must also have an equivalent credit to the Reserve account, so that the two accounts will show like amounts though on opposite sides. This plan is illustrated in the following entries. During 1922 the sinking fund accumulates a profit of $2,000, which was credited to Income and which must be reflected in the Reserve account as well- as in the Sinking Fund account. This profit was credited to Sinking Fund Income, which account has at the regular time been closed into Profit and Loss. We may now, therefore, debit Profit and Loss, not as a charge against the year's profits but as an impounding of them, or debit Surplus as an impounding of profits in general, and credit the reserve. The following entry will properly record the regular instalment of $50,000 and the income for one year on the preceding deposit : December 31, 1922 Profit and Loss (or Surplus) $52,000 To Sinking Fund Reserve $52,000 To set aside an amount equal to the annual deposit to the sinking fund, plus the profits accumulated for the year,. as follows: Annual deposit to sinking fund $50,000 Income on previous balance reported by trustee 2,000 1244 CORPORATE ACCOUNTING [Bk. III- Of course, if the Sinking Fund Income account was closed into the reserve, 4 no further credit of that amount to the reserve will be necessary. An entry similar to the above must be made at the end of each year, comprising the regular instalment and all accrued profits for the year. This entry presupposes, of course, that ad- ditions to the sinking fund have already been charged to the trustee and credited to income on December 31, 1922. As in- terest accumulations are reported by the trustee, adjusting entries are made to the Sinking Fund account; but under the plan adopted it may not be necessary to credit the Sinking Fund Re- serve until the end of the year, at which time the entry will in- clude both the regular $50,000 instalment and the accrued inter- est. If it is desired, as is frequently the case, to credit earnings directly to the Sinking Fund Reserve account instead of to In- come, the following entry would be required for the $2,000 above reported : December 31, 1922 Sinking Fund Cash $2,000 To Sinking Fund Reserve $2,000 For interest accretions to the sinking fund for year, as per report of the sinking fund trustee. If the Sinking Fund account and the Sinking Fund Reserve account are to be kept in harmony, certain adjustments may be required from time to time, as in the purchase of bonds of the issuing company or others at a premium. Referring to the in- vestment of $51,250 recorded in the previous section, instead of charging this premium to a premium account it may be charged directly to the Reserve. account by such an entry as that which follows: January i, 1924 Sinking Fund Reserve $1,250 To Sinking Fund Cash $1,250 (Full explanation here.) Ch. 23] ENTRY OF FUND TRANSACTIONS 1245 This entry, if used, would of course be incorporated in the entry referred to above. The amount might, if desired, be first charged to the Premium account and in turn closed into the Re- serve account. There are many ways of making entries and it would be impracticable to enumerate them all. 233. Accounts Kept by Sinking Fund Trustees It is necessary for the trustee of any fund to keep full and complete accounts so that the condition of the trust can be readily ascertained at any time. The accounts of the trustee and of the company should always be in absolute harmony on all matters pertaining to the bond issue and the sinking fund. The trustee will maintain accounts with Cash and with In- vestments, possibly opening a separate account for each kind of investment. "Sinking Fund of Blank Company" account will be credited by the trustee with the amounts of all sinking fund in- stalments paid to him. Its only debit will occur at the time the trustee, at the maturity of the bonds, takes them up, whether he has already invested his cash in them or whether they are still in the hands of scattered holders. The trustee of a bond redemp- tion fund would debit Bond Redemption Fund, on the contrary, with his purchases of bonds for redemption. Interest Payable or Coupons Payable account (with perhaps a separate account for each series of coupons, as ''Coupons No. i") is credited at the tune of the receipt of money with which to pay the interest, Cash being debited. The account is debited with the amounts of all interest paid to bondholders or coupons taken up. The credit balance therefore shows the amount of all unpaid but due interest for which the trustee has received the money to make payments. 234. Entries on Books of Sinking Fund Trustee To illustrate the entries on the books of the sinking fund trus- tee, the transactions in connection with the bond issue of the Lenox Iron Works ( 227) may be again taken. The first pay- 1246 CORPORATE ACCOUNTING [Bk. III- ment to the sinking fund trustee was $50,000 in cash on July i, 1921, this payment being made to meet the semiannual bond in- terest. The entry on the books of the Lenox Iron Works was as follows : July i, 1921 Bond Interest $50,000 To Cash ^>ntj $50,000 For payment of semiannual bond interest on $1,000,000 5% bonds, due today at the office of the trustee, The Grove Street Trust Company to whom the check has been issued. The corresponding entry on the books of the sinking fund trustee is shown below: July i, 1921 Cash $50,000 To Coupons No. i (Lenox Iron Works) $50,000 First deposit of cash for payment of Coupons No. i on $1,000,000 coupon bonds of the Lenox Iron Works. The Coupons No. i account will obviously remain open until all the coupons are paid. As payments are made, the trustee of course debits the Coupons account and credits Cash. Upon receipt of the first sinking fund instalment the following entry was made on the books of the Lenox Iron Works. December 31, 1921 Sinking Fund Cash $50,000 To Cash $50,000 (Explanation.} The corresponding entry on the books of the sinking fund trustee is as follows: December 31, 1921 Cash $50,000 To Sinking Fund (Lenox Iron Works) . 1 .'. $50,000 First sinking fund instalment of the Lenox Iron Works for redemption of $1,000,000 first mortgage 5% bonds of 1921, due January i, 1-941. The succeeding entries of the sinking fund trustee would, as in those shown above, correspond to the company's entries. CHAPTER XXIV REDEMPTION OF BONDS 1 235. Plans for Redeeming Bonds The due date of any issue of bonds is stated in the deed of trust and also on the face of each bond. The deed of trust usually provides also that if any instalment of bond interest is not paid when due, and default continues for a specified length of time, the principal is thereby matured and must be paid. In event of continued default in either the principal or interest, it is usually provided that foreclosure may follow, or perhaps the trustee is authorized to take possession of the mortgaged property and operate it for the benefit of the bondholders. The method of redeeming bonds depends largely on the nature of the particular bonds. The following methods are in general use: 1. Payment in cash at maturity through the sinking fund. 2. By calling certain bonds each year for redemption. Under this method the numbers of the outstanding bonds are placed in a box or hat, shaken up, and a given number of them drawn, those drawn indicating the bonds which are to be redeemed. Legal notice of the numbers drawn for redemption is given to the bondholders by advertisement in the daily papers, and the bonds specified cease to bear interest from the date of the draw- ing, or some other specified date. 3. Refunding at maturity, in which case the bonds are canceled and new ones issued in their place, the holders of the old bonds either taking new bonds, or cash secured by the sale of these new bonds, in exchange for their old bonds. 1 See also Book II, Ch. XI, "Redemption of Bonds linking Funds." 1247 1248 CORPORATE ACCOUNTING [Bk. III- 4. By serial payments. Under this plan serial bonds are issued, payable in instalments of so much per year during the currency of the bonds. 5. By conversion into stock of the company, either at a fixed date or at the maturity of the bonds, or at some other con- venient time prior to maturity. 236. Redemption of Bonds through Sinking Fund Bonds redeemed through the sinking fund are paid at ma- turity by the trustee, who then passes the canceled certificates over to the issuing corporation for final record. Sometimes the canceled bonds are burned, though more frequently retained by the company as a permanent voucher. The book entries at maturity of the bonds are very simple. To illustrate the entries necessary, the bond issue of the Lenox Iron Works may again be taken. This consisted of $1,000,000 of first mortgage 5% sinking fund bonds due January i, 1941. Assuming that the bonds have matured and that the sinking fund for their redemption amounts to $992,000, leaving $8,000 more to be made up by the company, book entries are required as follows: January i, 1941 Sinking Fund Cash $8,000 To Cash $8,000 Cash paid over to the trustee of the sinking fund as per request, being the amount still required by him for payment of $1,000,000 first mortgage bonds maturing this day. If the sinking fund had been scientifically calculated and maintained at all times at a given rate of interest without loss, the required amount for the redemption of the bonds should be available at their maturity in the sinking fund. It is, however, for obvious reasons seldom that the sinking fund is exactly equal to the maturing bonds. When a shortage occurs the company must raise the additional funds. If, on the other hand, the fund Ch. 24] REDEMPTION OF BONDS 1249 is in excess of the required amount, such excess must of course be returned to the company after the bonds are redeemed. Upon receiving notice from the trustee that all of the bonds have been redeemed, the following entry is made : January i, 1941 First Mortgage Bonds $1,000,000 To Sinking Fund Cash $1,000,000 For payment by the trustee of $1,000,000 first mort- gage 5% 2o-year sinking fund bonds of 1921 due this day. The trust deed has been canceled and the mortgage satisfied of record in the county re- corder's office. Through the above entry, both the bond and the sinking fund accounts have been closed out. This results in the can- cellation of two main accounts. The Sinking Fund Investments account should have been closed into the Sinking Fund Cash account when the trustee turned the securities into cash; the entry above being preceded by the following entry for the amount invested in securities : Sinking Fund Cash $900,000 To Sinking Fund Investments $900,000 For conversion into cash by the trustee of sinking fund securities held by him to the amount of $900,000. This entry is made regardless of whether the sinking fund investments are bonds of the issuing company or of other com- panies. The cancellation of all three accounts involved in the above entries might of course be accomplished through the one journal entry as follows: First Mortgage Bonds $1,000,000 To Sinking Fund Investments $900,000 Sinking Fund Cash 100,000 (Full explanation here.) t , ( , If a Sinking Fund Reserve account had also been created, it can now be disposed of, as there is no further need of preventing the declaration of dividends to the impairment of current assets. The Surplus account can be credited with the amount of this 1250 CORPORATE ACCOUNTING [Bk. III- reserve. Assuming that it has a credit balance of $1,000,000, the following entry is required : Sinking Fund Reserve .............................. $1,000,000 To Surplus .................................. $1,000,000 (Full explanation here.) 237. Bonds Drawn by Lot for Redemption When bonds are to be redeemed before maturity, the sinking fund trustee either advertises for the desired number of bonds at a stated price, draws certain bond numbers by lot for redemption at a fixed price, or buys them in the market at the best prices obtainable. If the bonds to be redeemed are drawn by lot, in the case of coupon bonds, notice thereof is given to the holders by means of newspaper advertisements; in the case of registered bonds, notices are sent direct to the holders. When bonds of the issuing company are purchased by the trustee, they are, according to the provisions of the trust agreement, either retained as a sinking fund investment unless resold later at a higher price or are handed over to the issuing company and canceled. The company's bonded indebtedness is in the latter case reduced to the extent of the bonds retired. The investor frequently objects to the plan of drawing bonds for retirement, because he never knows when his number may be drawn. He must therefore be on the lookout at each interest period for the announcement of drawings, thereby causing a certain amount of anxiety. If he should overlook the announce- ment, he would hold his bonds and be deprived of the use of his money for the ensuing six months, discovering his loss at that time through the fact that his coupons came back unpaid. Also the plan results in a very short investment period for those whose bonds are called first, and an uncertain investment period for all the holders of the particular bonds. On the other hand, the fact that called bonds are usually purchased .at a premium has a tendency to offset any trouble to which the investor may be put in watching for the newspaper notices of calls, Ch. 24] REDEMPTION OF BONDS 1251 The plan of selecting bonds for redemption by lot applies equally as well to debentures, short-term notes, and other obligations. Bonds of clubs, institutions, office buildings, and the like, are frequently issued under this plan of redemption. 238. Entries for Bonds Redeemed Before Maturity The entries for bonds of the issuing company purchased and held- by the trustee for sinking fund purposes, were set forth in the preceding chapter. When the company, either voluntarily or because of a stipulation in the deed of trust requiring it so to do, purchases bonds in the open market or calls them before maturity and cancels them, a different principle is involved. The security to bondholders, however, remains the same in either case; indeed, from the bondholders' standpoint the can- cellation of the bonds is preferable, since his margin of security automatically increases in proportion as the volume of out- standing bonds decreases. The trust agreement may stipulate, however, that as bonds are called for redemption and canceled, certain modification of the security held may be made. If no bond redemption fund were required by the deed of trust, or if one were required and the company in addition to its stipulated payments to this fund chose to purchase and cancel other bonds, the entry at the time of purchase would be simply : First Mortgage Bonds $3,000 Interest on Bonds 30 Premium on Bonds Purchased 150 To Cash $3,180 Purchase for cancellation of $3,000 of the Company's 5% bonds at 105 and accrued interest. But if the trust agreement of the Lenox Iron Works called for annual bond redemption instead- of a sinking fund, and if under this agreement the trustee of the bond redemption fund purchased on January i, 1924, $50,000 of bonds 2 and turned 8 Cf. 1231. 1252 CORPORATE ACCOUNTING [Bk. III- them over to the company to be canceled, an entry would be required as follows: January i, 1924 !< << First Mortgage 5% Sinking Fund Bonds $50,000 Premium on Bonds Canceled ^250 To Bond Redemption Fund Cash $51,25^ Purchase for cancellation of $50,000 of the Company's 5% bonds at 102^ through the trustee. If the trust mortgage provides that the fund shall be main- tained at a given amount, the company may be compelled to reimburse the trustee for the premium payment. This premium of $1,250 will at the proper time be closed into Profit and Loss. 239. Refunding Bonds As already stated, a bond issue may be renewed or "funded" by a new issue of bonds with equally as good or better security. Nearly all railroad bonds are issued with the expectation of refunding at maturity and when the company is of unquestioned financial strength such refunding is looked upon with favor. For illustration of the entries required where bonds are refunded, we will assume that the first mortgage 5% bonds of the Pleasant Valley Electric Railway Company for $10,000,000 matured July i, 1921, and that they were refunded by part of a new issue of consolidated first mortgage 5% 5o-year bonds for $20,000,000. The following entry is required for the refunding operation : July i, 1921 First Mortgage 5% Bonds (maturing) $10,000,000 To Consolidated First Mortgage 5% Bonds (or Cash) . $10,000,000 Refunding of $10,000,000 first mortgage 5% bonds due this day at the office of the trustee, the Barton Trust Company. The bonds have been canceled and returned and the mortgage satisfied of record. In cases such as this the new bonds may either be exchanged for the old, as assumed above, or they may be sold and the cash received be used for redeeming the maturing obligations. Ch. 24] REDEMPTION OF BONDS 1253 240. Redemption of Serial Bonds Serial bonds are usually paid in annual instalments of given amounts beginning a few years after the date of issue ; therefore the redeeming process is a continuous feature after it is once started. Like other mortgage bonds, serial bonds are usually payable at the office of the company's fiscal agent or at the office of the trustee, but in any case the money required for their redemption is paid over by the company as the instalments mature. Assuming that the first mortgage 6% serial bond issue of $3,000,000 of the Georgian Paper and Pulp Company is payable in instalments of $150,000 each year beginning February i, 1921, and that the date for paying the first instalment is at hand, the following retirement entry is made : February i, 1922 First Mortgage 6% Serial Bonds $150,000 To Cash $150,000 Payment of Instalment No. i of the $3,000,000 first mortgage serial 6% bonds. As the bonds are paid they are canceled and handed over to the company for record. In place of the above entry two entries may be substituted if desired, one crediting Cash and debiting the trustee as the cash is paid over, and the other debiting the bond account and crediting the trustee as the bonds are received by the company. Under the trust deed the company has the privilege of paying off additional instalments in order of serial numbers (or the reverse order), in advance of maturity, at 103 and interest. As already explained, 3 the premium paid for such redemption is in turn closed into Profit and Loss. In that case the entry differs from the above only with respect to premium paid, and is: First Mortgage 6% Serial Bonds $150,000 Premium on Redeemed Bonds 4.500 To Cash $154,500 (Full explanation here.) ' I 231. 1254 CORPORATE ACCOUNTING [Bk. III- 241. Entries for Convertible Bonds A convertible bond is one which under prescribed conditions carries the right of conversion into other securities of the same corporation. These convertible bonds may be exchanged for stock of the company at a stated price, provided the holders thereof care to take advantage of the privilege. For instance, the convertible 4^2% bonds of the American Telephone and Telegraph Company can be exchanged at par for stock of the company at $120 per share until March i, 1925. When the con- vertible bonds are issued, provision is of course made so that there may be a sufficient amount of unissued stock or other securities to which the conversion privilege will apply. The entries required to give expression to such a conversion are quite simple: Convertible Bonds, etc. ................................ $ ..... To Unissued Stock (or other security) ......... , ---- $ ..... Premium on Stock ........................... ..... (Full explanation.) 242. Redemption of Collateral Trust Bonds The entries for the redemption of collateral trust bonds are not different from those for the redemption of ordinary mortgage bonds, except that the security which had passed out of the company's possession at the date of issue now comes back. An extra entry is required to record this transfer. Assuming that the due date of the Harney Electric Company's $1,000,000 2o-year collateral trust 5% gold bonds, interest pay- able half-yearly, has arrived, that they have been paid by the trustee, and that the collateral has been released to the company, the entry required at the time is : /,- y!no OVo.l 10) wr'J Jnnwfip3 243. Redemption of Short-Tenn Notes Short-term notes are either secured or unsecured, and as they mature they are paid like other bond obligations, and the book entries required are similar to those for other classes of bonds. If the notes are secured by a deposit of collateral, an entry should be made as soon as the collateral is returned, removing the coU lateral from the Pledged Collateral account and returning it to the Investments account, as in the case of collateral trust bonds. Unissued or nominally issued bonds of the company that have been pledged as security for bank loans or other obligations, should in like manner be recorded in some distinguishing account, i viJxis on ng/u ,vnjiqrrioD t>rfj yd b'^iobni 244. Redemption of Equipment Trust Bonds Equipment certificates are usually issued in series, as Series A, B, C, etc., each being secured by a given portion of the equipment. As each instalment of the certificates is paid by the trustee out of money supplied by the company, the equip- ment trust certificates are canceled and returned to the company. As soon as a series is paid off, which may require two or three 1256 CORPORATE ACCOUNTING [Bk. Ill- instalments, the equipment thereunder is released to the com- pany. It is then transferred from the trust equipment account to the free equipment account. Assuming that upon payment of the first instalment of $1,000,000 of an equipment trust bond issue, one-fifth of the equipment held as security is released to the company, it would be reflected in the following entries, it being assumed that the released equipment is of the value of $2,000,000: July i, 1922 Equipment Trust Certificates $1,000,000 T> ^ L To Cash $1,000,000 First instalment of 6% equipment trust certificates paid this day, etc. This entry is then followed by a transfer entry somewhat as follows: Equipment Cars (or Locomotives) $2,000,000 To Equipment Trust Cars $2,000,000 For transfer of $2,000,000 of equipment released under equipment trust certificates. (Full explanation) 245. Redemption of Guaranteed Bonds . Guaranteed bonds are issued, as a rule, by subsidiary or affiliated companies, and should be redeemed by the issuing company. A contingent liability is, however, incurred by the guaranteeing company as soon as the bonds are indorsed, but it is not usual to make any entry in the books of account at the time. A complete record of the matter is of course made in the corporate minutes. If no entry is made when the bonds are indorsed by the company, then no entry is necessary at their maturity so long as they are duly paid by the issuing company. On the other hand, if an entry is made at the beginning, an off- setting entry is required when the bonds are paid by the issuing company. If the guaranteeing company is required to make payment for all or any part of the bond issue, it must then, of course, make an entry debiting the issuing company and crediting cash, and will look to the issuing company for reimbursement. Ch. 24] REDEMPTION OF BONDS 1257 246. Bonds in Default In case of default in the payment of bonds, or even in the interest thereof, the trustee is usually empowered by the deed of trust to enter upon and take charge of the mortgaged property for the benefit of the bondholders. In that event the company is forced into bankruptcy, or a receivership, or a reorganization of some kind, unless the bondholders consent to an extension or renewal, or to some other plan of adjustment that will permit the company to continue its career. Bond obligations not met at maturity should be removed from the regular bond account and credited to some other account that will clearly designate the nature of the obligation, as: Four- Year Secured 6% Notes $600,000 To Matured Four- Year 6% Notes $600,000 An account may even be opened for "Defaulted 6% Notes," "Overdue 6% Notes," "Renewed 6% Notes," or "Extended 6% Notes," as the case may require. f*> YM 1 VHJ vd jo rtottBXfiiiigitxri r. t< .n TO ,v 'to noi^rtoJyo fdf OT Jhosnoo 8T>f)Iofibhoci ariJ zttmu ,bi JBfij inya<.ieuii)f> lo mjlq i9dJo rao?. oi 10 Jjjwaf |i'j/orn*rt ocf hljjoda vihu^Bfii Jfi J-.MTI ion -anoijf;;- JorfJo Offtowo.} boJib'H:.) h'rtf, JftinooR btfod TfJu^at ariJ moil ,noilHdo t>rLt lo oiwlfifi odJ 'jJiingiciab ^^^y^"' ",*'jJD/. (v\) i^ioi bnoJikl" 10 ".asJoK -.v^ fev/MJ^'H 1 *- ^j'e^oVl i Part V Corporate Combinations 3hln3 .8 CHAPTER XXV COMBINATION BY LEASE' 247. Leases A common method of securing control of a competing concern is to rent its plant or property for a term of years, very much as one person would lease or rent properties from another. This plan is extensively used by transportation companies to gain possession of connecting lines. By this method the competition of the owner of the leased property is eliminated and the lessee company obtains valuable connections and a going business with- out incurring the cost and delay of construction. The lessor, on the other hand, besides being relieved of the operation of its properties, may receive more satisfactory returns in the form of rentals. The lessor company continues to maintain its separate existence, but its activities consist merely in receiving its assets and disbursing its income in the form of expenses and dividends. Nearly all leases require the operating company to pay taxes, insurance, and up-keep expenses of the leased properties, and to undertake other obligations of a more or less rigid nature. In mining operations the terms of the lease usually require the pay- ment of a certain amount per ton on the output of ore, with a specified minimum output, while in the case of a railroad or similar property the payment is likely to be a specified rental or a guaranteed dividend on the lessor's outstanding stock, with perhaps some participation in profits. > See Book I, } 557 . "59 1260 CORPORATE ACCOUNTING [Bk. III- The lessor is given access to the accounts and records of the lessee as far as they relate to the leased property during the life of the lease. Leases of large properties are usually matters of public record and the details thereof accessible to the public. 248. Entries for Property Leased Leased properties continue in the ownership of the lessor and must be returned at the expiration of the lease. Where the properties taken over are of such a nature that they are merged and perhaps consumed, as for instance, equipment and supplies, the lessee usually absorbs them into its own accounts and at the expiration of the lease either pays for them in cash or returns other equivalent assets. The assets so absorbed may be charged to the property accounts already in the ledger and credited to the lessor, or else be charged to separate accounts. The record of leased property stands as entered until the lease expires, while repairs and minor improvements on the property are usually charged to operating expenses. Permanent improve- ments would usually be charged against the lessor, the matter being determined by the terms of the lease. On the balance sheet, leased properties and the owner's credits may appear among the assets and liabilities as cancelling amounts, or may be entered on both sides "in short," in order to indicate their relation to other items; or they may be mentioned in a footnote to the balance sheet, or even be omitted entirely. If they are merged and included in the lessee's properties, a footnote may not be necessary, but the lessor's account must be included in the liabilities. Corresponding, though reverse, entries should be made on the books of the lessor for the properties conveyed by the lease, in case it is decided to make book entries at all. It is sometimes considered good practice to debit the leasing company and credit the property leased. Such an entry might be suitable where only a part of the property is conveyed, in order to distinguish between properties leased and properties operated. Ch. 25]] COMBINATION BY LEASE 1261 249. Entries for Guaranties When guaranties of interest or dividends are included in the terms of a lease, book entries are not absolutely necessary to record the contingent liability incurred ; and yet it is good business practice so to record such liabilities as to keep the obligation continually before the stockholders. The Pennsylvania Railroad Company does not enter such guaranties in its ledger accounts, but in its annual report a com- plete list of them is included. If book entries are made for guar- anties, they must obviously be for record only, because as contingent entries they would offset each other in the accounts. In the annual balance sheet they should be exhibited either among the accounts (in short or otherwise), or as a footnote thereto. 250. Lease Terms To illustrate the entries required when properties are leased by a corporation, assume that the Vermont Mining and Smelting Company has leased a mine from the Union Mining Company for a term of 30 years. The properties taken over comprise the mine, valued at $400,000, buildings and equipment valued at $30,000, and supplies valued at $8,500. At the termination of the lease the properties are to be returned to the Union Mining Company in as good condition as when taken over, except as to the ore mined. The Vermont Mining and Smelting Company agrees to pay as rental for the mine a guaranteed annual dividend of 4% on the Union Mining Company's capital stock of $1,000,000 during the life of the lease, and a royalty of 10 cents per ton for every ton of ore mined. The Vermont Mining and Smelting Company leases also a short railroad and its equipment, valued at $3,000,000, of the Wilson Transportation Company. The lease is to run for 30 years, at the end of which time the property is to be returned in good condition. The lessee is to guarantee during the existence of the lease an annual dividend of 6% on the capital stock 1262 CORPORATE ACCOUNTING [Bk. III- ($2,000,000) of the lessor company as rental, and is in addition to pay all taxes, improvement expenses, and interest on the out- standing bonds, and to make all needed replacements. The Vermont Company finds it necessary to expend for im- provements on the Union Mining Company property $100,000, and on the railway $400,000; and in order to secure funds for this, the company issues $500,000 of short-term notes payable $100,000 each year for 5 years and drawing 6% interest. The notes are secured by a deposit with the trustee of $500,000 stock of the Lone Ridge Mines Company, a successful subsidiary. The notes are sold at 95 to a banking firm. The output of ore from the leased mine during 1921 is 122,000 tons, and the net income therefrom to the lessee after paying operating and repair expenses is $85,000, out of which the rental must be paid. The Union Mining Company is able, out of the rental received, to apply 3% of the value of the mine leased on its extinguishment fund and also to apply to the dividend fund 2 K% n its capital stock. The operations of the leased railway for the year are shown in the following summary : Gross Freight Earnings $750,000 Operating Expenses $230,000 Replacements and Repairs 145,800 Improvements, etc., charged off 14,000 Guaranteed Dividend to Lessor. 120,000 Total Deductions 509,800 Net Earnings $240,200 The accounting procedure to be considered in connection with the foregoing transactions involves entries for: 1. Lease of the mine and equipment. 2. Lease of the railway and equipment. 3. Issue of notes and expenditures for improvements on leased properties. 4. Distribution of rentals of leased properties at end of year. Ch. 25] COMBINATION BY LEASE 1263 5. Union Mining Company at the beginning and end of the first year. 6. Wilson Transportation Company at the end of the year's operations under the lease. 251. Entries for Lease of Mine ', It is natural to suppose that the lessee will aim to secure from the mine during the life of the lease, all of its ore, unless the lease contains some limitations. The outlay for improvements and extensions made by the lessee must be written off during the life of the lease as operating expenses, excepting as to any movable equipment belonging to the lessee. The mine buildings and equipment are valued at $30,000, and must be returned when the lease expires. The supplies taken over are valued at $8,500, and must be made good when the lease expires. Assuming that the Vermont Company decides to bring these properties into its own accounts, the following entry is made: Leased Properties of Mining Company ................... $438,500 To Union Mining Company for Leased Properties. .. $438,500 For mine, valued at $400,000, buildings and equipment at $30,000, and supplies at $8,500, taken over under 30-year lease, to be returned at expiration thereof. It will be seen that one entry offsets the other. They must stand thus in the ledger accounts until the lease matures and then be eliminated by a counterbalancing entry. Under an alternative plan that is also good practice, no entry in the books is necessary for the leased properties, save the record of the transaction hi the minutes of the directors and stock- holders. The improvements on the mining property, costing $100,000, should be charged to "Improvements Account of Union Mine," and then written off one-thirtieth each year during the life of the lease. Any improvements of succeeding years may be spread over the remaining years of the lease's existence. Expenditures or the up-keep of buildings and equipment, replacements and 1264 CORPORATE ACCOUNTING [Bk. III- supplies, should be charged like the regular company expenses to certain operating expense accounts. 252. Entries for Lease of Railway The same general accounting procedure may be followed for the leased railway property as for the leased mine. Both road and equipment must of course be kept in good condition during the tenure of the lease. The value of the road taken over may or may not be entered upon the books of the lessee, but it is ad- visable to enter the equipment. Up-keep and operating expenses are to be considered as charges against current operations, as is the guaranteed 6% divi- dend of $120,000 per year. All expenditures for extensions or improvements, however, must obviously be spread over the period of the lease if their normal life will extend to the date of expiration of the lease; otherwise they will be depreciated at the usual rates. In either event they will be completely written off when the lease expires. Leased Equipment of Wilson Transportation Company $. . . . To Wilson Transportation Company, Leased Equipment $ For equipment taken over under lease, to be returned at the expiration thereof (full details). It is probable that rolling stock and any other properties of the lessee company used in the operation of the railroad property will be transferred to the leased road, and then taken back at the expiration of the lease. 253. Entries for Improvements and Note Issue The expenditures for improvements on leased properties should be charged against the improvement accounts of the re- spective properties in order to keep the different expenditures separate and distinct. The security back of the note issue should be listed separately in the explanation of the journal entry, or else a notation should be made stating the disposition of the col- lateral. Everything must be so recorded as to be clearly under- Ch. 25] COMBINATION BY LEASE 126$ stood. Interest on the notes and the amortization of discount must be charged each year as operating expenses of the business. The recording entries may be as follows: Cash $475,000 Bond Discount 25,000 To Collateral Serial Notes $500,000 For sale to bankers at 95 of $500,000 of short-term 6% notes, payable $100,000 each year for 5 years, secured by a deposit with the trustee of $500,000 stock of the Lone Ridge Mines Company. Pledged Securities for Serial Note Issue $500,000 To Stocks of Other Companies $500,000 (Full explanation here.) Union Mine Improvements $100,000 Wilson Railway Improvements 400,000 To Cash $500,000 (Full explanation' here.) ic**-.! *h lo arfood 3fU [oramrahtaa 254. Adjusting Entries at End of First Year The entries which follow indicate adjustments at the end of one year on the books of the Vermont Mining and Smelting Com- pany. Only such entries are shown here as affect the accounts of the properties leased, interest on bonds, etc., being omitted. December 31, 1921 Union Mine Operation $ 3,500.00) Wilson Railway Operation 14,000.00 To Union Mine Improvements 'yT' < ^ 3i333-33 Wilson Railway Improvements '!?" l . u . (*'. . . 13,333-33 Discount 833.34 To write off 1/30 of improvements and discount on notes in proportion to the improvements, 1/5 and 4/5: Improvements cost $500,000 Discount 25,000 oos ,t fcl ,{?-) Union Mine Operation $52,200 To Union Mining Company $52,200 For royalties and guaranteed dividends for 1921 on leased mine, as per terms of lease, being 10 cents per ton on 122,000 tons ore mined, $12,200, and 4% dividend on $1,000,000 of capital stock, $40,000. 1206 CORPORATE ACCOUNTING [Bk. III- Wilson Railway Operation $i 20,000 To Wilson Transportation Company $130,000 For application of guaranteed 6% dividend on Company's outstanding stock after payment of taxes, improve- ments, operating repairs, etc., according to the terms of the lease. 6% on $2,000,000 capital stock =$120,000. Union Mining Company $ 52,200 Wilson Transportation Company 120,000 To Cash $172,200 For payment of royalties and dividends for leased proper- ties, per statement. Union Mine Operation ??.? l ./;A fi .".* 2 . $ 29,300 Wilson Railway Operation 240,200 To Profit and Loss $269,500 For net earnings after paying royalties and guaranteed dividends, per agreement. 255. Entries for Union Mining Company Entries may or may not be made on the books of the lessor company to show the execution of the lease. The following en- tries are suggestive, though a different plan might be followed. Only the accounts affected by the lease are included in the entries, no attention being given to accruals or intermediate entries. Entry when lease is made: January r, 1921 Properties Leased to Vermont Mining and Smelting Com- pany $438,500 To Mining Property $400,000 Buildings and Equipment 30,000 Supplies ". . . ' 8,500 For lease of properties to Vermont Mining and Smelting Company, as per terms of the lease (full explanation.) Entries at end of first year: December 3 i f 1921 Cash $52,200 To Income $52,200 Income from mine and properties leased to Vermont Mining and Smelting Company, as per terms of the lease: 122,000 tons of ore mined, at 10 cents per ton. $12, 200 Guaranteed dividend on capital stock 40,000 Ch. 25] COMBINATION BY LEASE 1267 Income $52,200 To Extinguishment of Mines Reserve $12,000 Dividends Payable 25,000 Profit and Loss 15,200 For disposition of income from leased properties. 256. Entries for Wilson Transportation Company Since all of the property, roadbed, and equipment of the rail- way has been leased to the Vermont Mining and Smelting Com- pany, it is apparent that no separate entries are necessary in the accounts of the Wilson Transportation Company. The property accounts stand as they are on the books, representing as they do the investment therein. At the end of the year, however, entries must be made in the books to record the dividends guaranteed by the Vermont Mining and Smelting Company. December 31, 1921 Cash . $120,000 To Income $i 20,000 Being guaranteed income from road and equipment leased to Vermont Mining and Smelting Company, as per terms of the lease. ;j>d) >)[ Income $120,000 To Dividends Payable $120,000 For dividend guaranteed by the lessee, Vermont Mining and Smelting Company, payable January 25, 1922. io -(.^J/ntKjo-o:; oJ 0' *fJ vJ L .)g \ : . . CHAPTER XXVI HOLDING COMPANIES i v/ir,qznf .Ogs; 257. Definition of Holding Companies While, strictly speaking, a holding company is a corporation created for the purpose of dealing in the securities of other corporations, yet if the state laws permit, any company whose charter so provides may purchase the stocks and bonds of other companies. In some cases where a consolidation of two or more companies is desired, one of the consolidating companies, possessing a liberal charter, may serve the purpose of both operat- ing and holding company. For accounting purposes a holding company may be considered as one which owns or controls the stock of another and is therefore able to direct its policies. 258. Manner of Effecting Control Ownership of a bare majority, sometimes even less than half, of the stock of the competing companies is sufficient for effective control. When the holding company itself owns less than a majority of the stock of the subsidiary, control is usually maintained through the apathy, or inability to co-operate, of the stockholders in whom rests the "balance of power." Some- times it is secured and maintained through ownership of addi- tional stock by interests which themselves control or are con- trolled by the holding company. Control is actually accom- plished by selecting directors who will pursue the desired policies. 259. Combination by Interlocking Directorates Combinations may be, and often are effected by means of interlocking directorates. To accomplish such a result the same 1 See also Book I, Ch. LVII, "Holding Companies," and Book II, { 42-49. 1268 Ch. 26] HOLDING COMPANIES 1269 interests, or interests working in harmony, must own a majority of the stock of each of the companies controlled. Under this method, either the same men appear as directors of the different corporations to be controlled, or men representing the interests which control the allied corporations are so effectively distributed through the various boards of directors as to control the corporate operations. Each company is to all intents and purposes a separate and independent company, the control exercised through its board of directors not affecting its status; yet ah 1 act in harmony. Combination by interlocking directorates does not interest the accountant except as he may be called upon to prepare a consolidated balance sheet for the companies controlled 2 or show the relationship of these companies through their stockholdings. 260. Status of the Subsidiary Company The sale of the stock of a company to a holding company in part, or even in whole, does not necessarily affect its accounting, save as to the record of stock transferred. Nor is its legal status changed in any way, whether or not it becomes a subsidiary absolutely under the control of the holding company. The most notable example of holding and subsidiary companies is perhaps found in the case of the United States Steel Corpora- tion, which is not an operating company. All dividends de- clared by the constituent or operating companies are paid to their own stockholders; and the holding company, ^though controlling these constituent companies, benefits by such dividends only as a stockholder and to the extent of its holdings of their stock. 261. Accounting Procedure of Holding Company The example which follows shows the accounting procedure involved where a corporation has been organized for the sole purpose of purchasing the stocks and bonds of other companies. The Karlow Manufacturing Company was incorporated . J See Ch. XXXIV, "Consolidated Statements." 1270 CORPORATE ACCOUNTING [Bk. III- July i, 1921, for the purchase of stocks and bonds of other established companies as a means of providing income and of harmonizing conflicting interests. The capital stock is $1,000,- 000. composed of 10,000 shares of the par value of $100 each, and $950,000 of this capital stock has been subscribed and paid in. Incorporating expenses amount to $10,000. The proceeds from the stock subscriptions have been used for the purchase of securities as of July i, 1921, as follows: 1. $100,000 of 5% first mortgage bonds of the Vulcan Iron Works at 95 and accrued interest for three months $ 96,250 2. $200,000 of refunding 5% first mortgage bonds of the Rapid Transit Corporation at 98 and accrued interest for three months 198,500 3. 2,000 shares of 7% cumulative preferred stock of the Longworth Stel Company at 105, ex-dividend 210,000 4. 500 shares of 6% preferred stock of the Brownson Trading Company at 96 and accrued dividend for six months due this day 49,500 5. 3,000 shares of common stock of the Rockway Iron Mining Company at par, payable one-half down and the balance in three months . . 300,000 6. 1,000 shares common stock of the Delaware River Power Company in exchange for a similar number of shares of this Company 100,000 $954,250 This requires an immediate cash expenditure of $714,250 for the first four items in the above list of securities purchased, totaling $554,250, plus a payment of $150,000 on the fifth item and $10,000 for expenses of incorporation. Stock to the amount of $100,000 must also be issued for the sixth item. This leaves $135,750 of cash on hand toward the final payment of $150,000 on the fifth item. The balance of $14,250 will be met out of receipts of income during the first three months, or if these should fall short after the payment of operating expenses in- curred during that period, a short-time loan could be made. Dividends and interest received for the six months' period ending December 31, 1921, amount to $27,000; bond interest accrued amounts to $3,750; and accrued cumulative dividends, to $1,500. The operating expenses for this period aggregate $2,800. A dividend of 2% on the company's stock, payable Ch. 26] HOLDING COMPANIES 1271 January 15, 1922, is declared by the directors at their meeting on December 31, 1921. All investments are to be carried on the books at the purchase price. The incorporating expenses are to be written off over a period of ten years. 262. Accounting Requirements The entries to record properly the transactions of this example are simple and need not be set out in full. The procedure and book records required at the time of incorporation have already been fully explained. When stocks of other companies are pur- chased, it is customary to debit the cost price to some suitable account, as "Investments," "Stock Investments," or "Stocks of Other Companies." A like procedure is followed in the purchase of bonds of other companies, substituting the word "Bond" for "Stock." Sometimes both stocks and bonds are included in one account, but when this is done a special record is kept to show the details of the various securities. 3 As has been stated, 4 dividends, even on preferred stock with a fixed dividend rate, become an actual liability only at the time of declaration and should not be entered as an accrual. Com- panies such as this, however, frequently accrue such dividends receivable, feeling that their investments are sound and will certainly pay the dividend. Such accrued dividends should, if entered, be carried in an Accrued Dividends account. Interest on bonds, however, does accrue de diem in dism and its accrual is unquestionably a proper practice. It should be carried in an Accrued Bond Interest Receivable account. The income from such investments may be credited to a general "Income" account, or separately to suitable accounts which distinguish between stock dividends and bond interest. The income and expenditures and the resultant assets and liabilities of this company at the close of the first half-year are reflected in the accompanying income account and balance sheet: See 1} 112, 113. See} 116. 1272 CORPORATE ACCOUNTING [Bk. III- HARLOW MANUFACTURING COMPANY INCOME ACCOUNT FOR Sfx MONTHS ENDED DECEMBER 31, 1921 Debits July i, 1921 Bond Interest Accrued $ 3, 750 Dividends Accrued i ( 5oo December 3 1, 1921 Balance (income for > six months) 27,000 General Expenses. $2,800 Incorporating Expenses Writ- ten Off 1,000 Net Income for period 23,200 $27,000 Credits December 31, 1921 Preferred Dividends Received $ 8,500 Preferred Dividends Accrued. 1,500 Bond Interest Received 7,5o Bond Interest Accrued 3,75 Dividends 11,000 ,250 Income brought down $27,000 $27,000 Balance $23,200 BALANCE SHEET, DECEMBER 31, 1921 (End of first six-month period) Assets Cash on Hand Investments: Bonds of Other Companies Stocks of Other Companies Bond Interest Accrued Dividends Accrued Incorporation Expenses, Bal- ance. . . $ 9,950 291,000 658,000 3,750 1,500 9,000 $973,200 Liabilities Capital Stock: Authorized $1,000,000 Unissued 50,000 Outstanding Dividend No. i, payable January 15, 1922 Undivided Profits . . $950,000 19,000 4,200 $973,200 263. Operating Company Purchasing Controlling Interest In the following example the purchasing company is itself actually engaged in operating its plants, but by the purchase of Ch. 26] HOLDING COMPANIES 1273 < -M" ft s 5 ^ J w H" W 1^ W H Jz; 1-1 o < a c w 15 fc I O O O O o o o tr> O *-O CO M CO w w b ? o3 >> 13 rued Ch lus U PQ Q < < C^ oooooooo OOOOOJOQO o >-< ^o o \o f^- o S 4> -S <" 1274 CORPORATE ACCOUNTING [Bk. Hi- Stock it secures control of a company engaged in producing an article needed by it in the manufacture of railway equipment. This is a very common form of holding company. The United Equipment Company has purchased $1,500,000 of the outstanding stock of the Nelson Car Wheel Company at 105, ex-dividend. As payment therefor it is to give $1,000,000 of its unissued common stock at 125, $150,000 of its unissued preferred stock at no, and the balance in cash. The financial statement of the Nelson Car Wheel Company is shown on the preceding page. The balance sheet of the United Equipment Company is as follows : UNITED EQUIPMENT COMPANY BALANCE SHEET, JULY i, 1921 Assets Property, Plants and Equipment $8,324,500 Liabilities Capital Stock Preferred (Authorized $5,000,000) $4,000,000 Inventories of Stock and Material 3,240,800 Capital Stock Common (Authorized $10,000,000) 7,000,000 Investments in Stocks and Bonds of Other Com- panies 2,160,000 First Mortgage 5% 20- Year Bonds, Outstand- ing. . 2,500,000 Cash on Hand and in Banks 895,940 (Authorized $5,000,000) Notes and Bank Loans.. . 1,680,000 Accounts Receivable . . . 2,?6o, 300 Accounts Payable 1,74.0,300 Notes and Loans Receiv- able 1, 34.3, 400 Accrued Interest, Taxes, etc 172,100 Sinking Fund Deposit with Trustee 326,900 Dividends for Half- Year Unpaid 420,000 Other Assets 8?7.IOO Sundry R&serves 996,630 Surplus 1,200,000 $19,709,030 $19,709,030 The points of interest in the illustration are the entries on the books of the United Equipment Company for the purchase of stock, and the entries on the books of the Nelson Car Wheel Company. These entries are shown on the following pages. Ch. 26] HOLDING COMPANIES 1275 264. Entries on Books of Purchasing Company The only entries on the books of the United Equipment Company are in the accounts relating to capital, cash, invest- ments, and premium. The premium of $75,000 on stock pur- chased is included in its cost and charged to Investments, thus reflecting as nearly as possible the market value of the stock. Investments in Subsidiary Companies $1,575,000 To Stockholders of Nelson Car Wheel Company. . $1,575,000 For purchase of 15,000 shares, par value $1,500,000, of the capital stock of the Nelson Car Wheel Com- pany at 105, to be paid for as follows: 10,000 shares common stock at 125. . . . $1,250,000 1,500 Shares preferred stock at no 165,000 Cash for the balance '. 160,000 Total investment $1,575,000 Stockholders of Nelson Car Wheel Company $1,415,000 To Capital Stock Common $1,000,000 Capital Stock Preferred 150,000 Premium on Stock Sale 265,000 For issue of stock to the vendors of the Nelson Com- pany stock, as above. Stockholders of Nelson Car Wheel Company $160,000 To Cash *i6o,ooo For settlement of balance on stock purchased of sundry stockholders. A more conservative practice would consider that the stock of the Nelson Car Wheel Company cost only the par of the stock issued for it plus the amount of cash paid, or in other words that the premium was the result of merely a trading valuation. In this case the entries would be : Investments in Subsidiary Companies $1,310,000 To Stockholders of Nelson Car Wheel Company. . Stockholders of Nelson Car Wheel Company $1,150,000 To Capital Stock Common . Capital Stock Preferred. Stockholders of Nelson Car Wheel Company. . $160,000 To Cash. . . $1,310,000 $1,000,000 150,000 $160,000 1276 CORPORATE ACCOUNTING [Bk. III- As a result of the above entries, the cash of the purchasing company is reduced ' to $735,940, investments increased to $3,470,000, outstanding common stock increased to $8,000,000, and outstanding preferred stock increased to $4,150,000. All other items in the balance sheet remain as previously stated. New certificates of stock must now be issued to the selling stock- holders of the Nelson Car Wheel Company. Suitable entries must also be made in the official records of the company, com- prising the minute book, stock register, and stockholders ledger. 265. Entries on Books of Selling Company No entries for the sale of its stock are required on the books of account of the Nelson Car Wheel Company. The sale was a personal matter with the stockholders of that company and one in which no official action is required by the board of directors. Any necessary entries must of course be made in the transfer book and stock book, and new certificates be issued in exchange for those canceled. If for convenience or any other reason the transactions were handled as a company matter, the entries in the general ledger might be as follows : July i, 1921 Stock Clearing Account (or United Equipment Company) $1,575,000 To Sundry Stockholders $1,575,000 For sale of $1,500,000 stock of this Company by sundry stockholders to the United Equipment Com- pany at 105. Stock of United Equipment Company $1,415,000 Cash 160,000 . To Stock Clearing Account (or United Equipment Company) $1,575,000 Stock of the United Equipment Company and cash received in exchange for $1,500,000 of stock of this Company, as above, being as follows. 10,000 shares common stock at 125 $1,250,000 1,500 shares preferred stock at no. ... 165,000 Cash for the balance ; . . 160,000 Ch. 26] HOLDING COMPANIES 1277 Sundry Stockholders $1,575,000 To Stock of United Equipment Company $1,415,000 Cash 160,000 For stock received as above and cash turned over to the sundry stockholders, as per agreement. 266. Parent Companies 5 The term "parent company" is rather loosely used. Gen- erally it means a corporation holding the patent rights to some, invention which it markets through subsidiary companies, either selling the product to them or allowing them to manufac- ture it on a royalty basis. Each investment made by the parent company in an under- lying company's stock may be charged to "Investments" account, or to a special account carrying the name of the particu- lar stock purchased, as "Stock of Canadian Motors Corpora- tion." Sales of machines may be made to subordinate com- panies on liberal terms of credit, and settlements made at con- venient times as collections are made from purchasers. The parent company's income is derived from sales to subordinates, from royalties received from subordinates, and from dividends on its investments in the various companies. See Book I, 527, and Book II, 49. 1 'JW 321D tftQlJJBIOfriCO ^mll38 Sffo Vfi<} *orfqrni' $toW$di wgiam A .aioaaa aJmoqioo di lr> noilfjiwjp.il in . 270. General Procedure for Merger The agreement for a merger may stipulate that one or more of the merging companies shall first modify in some way its exist- ing assets or liabilities. Usually, however, the new corporation takes over at once, as far as it legally can, the entire rights, property, privileges, and franchises of the constituent corpora- tions as "going concerns," continuing the business of each, ful- filling all existing contracts, collecting all outstanding claims, and discharging all the current liabilities. This is a form of com- bination that has in many cases proved effective and satisfac- tory. The following example illustrates the manner of merging sev- eral independent concerns, one of which is a partnership. The details and the accounting requirements are taken up in proper sequence. Although this example is made somewhat exhaustive in order to bring out the important points, it is of course impos- sible to present all of the points that may come up in connection with a merger. 3-)aGi{y. 271. General Conditions of the Merger Three corporations and a partnership are to be combined. All are prosperous manufacturing concerns in the same or allied industries. They are to become incorporated under the laws of New Jersey as the "Long-Bain Manufacturing Company" with an authorized capital stock of $16,000,000, of which one-half is to be common stock, and one-half 7% cumulative preferred stock; par value of shares, $100 each. There is also to be an issue of first mortgage 5% 3O-year sinking fund bonds of $5,ooo ; - Ch. 27] COMBINATION BY MERGER OR PURCHASE ooo. They are to be coupon in form and in denominations of $1,000 and $10,000, with the privilege of registration as to princi- pal. 272. Statement of Concerns to be Merged The new company is not interested in the valuation at which the assets are carried on the books of the old companies. All that concerns it is their real worth, as determined by the reports of the appraisers and accountants. These reports show the fol- lowing valuations, good-will being carried for the present at the valuation at which it was shown on the books of the two com- panies which carried it. STATEMENT OF MERGING COMPANIES JANUARY i, 1922 r OC,.:/.j.0 *OOC,?; 1 Long Company Bain Company Vine Company Bell & Davis xtfg LKjjqaD Total Assets Cash $ 572,800 $ 272,500 $ 33,800 $ 36,100 $ 915,200 Notes Receivable. . Accounts Receiv- able 340,600 1,021,300 135,800 492,750 69,100 162,800 114,000 82,400 659,500 1,759,250 Prepaid Charges. . . Investments 46,200 'COO.OOO 38,150 it;o,ooo 9,200 4,000 25,000 97,550 675;. ooo Stock and Material Supplies 964,300 175,100 510,000 51,900 188,800 7,800 '152,000 12,400 1,815,100 247,200 Pledged Securities 120,000 31.OOO 155,000 Due from Bain Company 8^,000 16,000 101,000 Furniture and Fix- tures . 125,000 62,000 22,000 14,000 223,000 Patents, Patterns and Tools 450,000 244,850 132,500 92,000 919,350 Buildings and Plant Good-Will 4,390,000 I OOO OOO 3,359,000 450,000 250,000 110,000 8,309,000 1,250,000 Sinking Fund 740,000 740,000 Total $10,410,300 $5,436,950 $1,326,000 $692,900 $17,866,150 1282 CORPORATE ACCOUNTING [Bk. Ill- Long Bain Vine Bell & Company Company Company Davis Total Liabilities Secured Loans .... $ Notes Payable. . . . 685,000 Accounts Payable.. 350,000 Accrued Charges. . 37,Qoo Reserve for Depre- ciation 345,100 Reserve for Bad Debts 10,000 Reserve for Insur- ance 105,500 Mortgage Payable Interest Accrued on Mortgage Payable Dividend Payable. 230,000 First Mortgage 5% Bonds 2,500,000 Capital Stock 5,000,000 Surplus 1,146,800 100,000 270,000 540,000 11,640 120,500 $ 30,000 150,000 75,ioo 202,600 205,100 8,200 6,200 54,000 1,000 300,000 250,000 20,000 4,Soo 105,000 30,000 500 3,500,000 600,000 355,000* 480,000 30,000 130,000 1,180,100 1,297,700 63,940 519,600 I7.5io 105,500 570,000 S.ooo 2,500,000 9,455,000 1,656,800 Total $10,410,300 $5,436,950 $1,326,000 $692,900 $17,866,150 * Capital to credit of partners at this date. Profits for Four Years: Long Company Bain Company Vine Company Bell & Davis Total For Year 1918. . . 1919... 1920. . . 1921. . . . $ 550,000 640,000 680,000 760,000 $ 290,000 340,000 430,000 370,000 $ 45,000 71,000 57,000 62,000 $ 22,500 29,500 26,400 38,600 $ 907,500 1,080,500 1,193,400 1,230,600 Total $2,630,000 $1,430,000 $23^,000 $117,000 $4,412,000 Average $ 6?7,!;oo $i- 8,000,000 The above assets and liabilities of the Long Company have been taken over this day at the valuations shown, as per report of the engineers and account- ants, in full payment for $8,000, ~oo capital stock of this Company, as per order of the directors and agreements previously entered into. An equivalent of common and preferred stock has been issued in exchange therefor, as per agreement. Total assets ........................ $12,033,500 Total liabilities ..................... 4,033,500 Capital issued,^, 3 ^ HMR ^. b/ml 8,000,000 Transfer of assets and liabilities of Bell & Davis. Cash 4 ......... .................................... $ 6,100 Notes Receivable ............................. ,,>...; 1 14,000 Accounts Receivable ................................ 82,400 Prepaid Charges ................................... 4,000 Investments ......................... . ........... . . 60,000 Stock and Material ....................... .......... 152,000 Supplies ........................................... 12,400 Due from Bain Company ............................ 16,000 Furniture and Fixtures .............................. 14,000 Patents, Patterns, and Tools ......................... 92,000 Buildings and Plant ................................ 1 10,000 Good-Will ......................................... 145,000 To Notes Payable ............................ $ 75,100 Accounts Payable ......................... 205,100 Accrued Charges. . ...................... . . 6,200 Reserve for Bad Debts ..................... 1,000 Mortgage of Bell & Davis .................. 20,000 Interest Accrued .......................... 500 Bell & Davis .............................. 500,000 (Full explanation, as above.) The assets and liabilities of the Vine Company are transferred 4 After payment of $30,000 secured loans. Ch. 27] COMBINATION BY MERGER OR PURCHASE 1291 to the books of the new company in like manner after the deduction of the $30,000 to be paid out in dividends. As the assets and liabilities of the Bain Company are to be retained and carried in its own ledger, they are not to be taken into the home office accounts. The books of this company are to be kept as heretofore, and the only change apparent will be that of ownership, with a reflected increase in capital, surplus, and good-will accounts. The ownership of this branch will be represented in the home office books in a distinguishing account, as "Bain Plant," "Bain Branch," "Investment in Bain Plant," or under some other suitable caption. Since this plant cost $5,000,000, it will therefore be represented at the same valua- tion on the new company's books. The entries are as follows: Bain Plant Investment $5,000,000 To Bain Company ... $5,000,000 For transfer from Bain Company of all assets, liabili- ties, etc., valued at $5,000,000, as per statements on file, in exchange for an equivalent of stock of this Company, as per agreement. Certain of the assets of the Bain branch might with advantage be included in the home office accounts, in which case the above amount would be correspondingly reduced. At this time the following entries, which are self-explanatoiy, might also be made: Incorporation Expenses $25,000 To Cash ..dtx; $25,000 For incorporation expenses and other charges, including professional services of attorneys and accountants. Treasury Stock ... - r .. $720,000 To Donated Capital (or Donated Surplus) $720,000 The consolidating companies have this day donated to the Long-Bain Company, for working purposes, one- tenth of their holdings of common stock 10% of $7, 2oo,ooo=$7 20,000, entered at par value. This transaction should be completed before the final issue of certificates has been made to the various stockholders. I2Q2 CORPORATE ACCOUNTING [Bk. III- 279. (3) Entries for Retirement of Outstanding Bonds and Mortgages of the Merging Concerns First entry: T, j r T ^ Bonds of Long Company $2,500,000 Mortgage of Bell & Davis . f .! yji 20,000 Interest Accrued ;. yoi 500 Bain Plant Investment 304,500 Mortgage of Vine Company 250,000 To Unissued Bonds .' . . * $3,075,000 For refunding of all outstanding bonds and mortgages of the merging concerns, as per merger agreement, entry of Bain Plant Investment including mortgage of Bain Company and accrued interest on same $4,500. Since the bonds of the Long Company and the mortgages of the Vine Company and of Bell & Davis, with accrued interest, have been included in the accounts of the new company, they can be readily canceled by an offsetting entry. This is not true, however, of the mortgage of the Bain Company branch, since all accounts are retained in its own books. The outlay on account of this branch must then be regarded either as an additional ex- penditure or as an investment and charged up accordingly. Since there is an equivalent issue of bond obligations, there is no additional investment of the company's capital, but the liability is transferred from the branch books to the home office books. Second Entry: Donated Capital $250,000 To Treasury Stock $250,000 A bonus of donated common stock given to holders of refunded bonds of the Long Company, 10% of $2,500,000. 280. (4) Entries Relating to Sale of Securities Incorporation Expenses $200,000 To Stock Subscription (or Underwriters) $200,000 Being an issue of stock to the underwriters of this Company for services rendered in organizing, and in full payment of their subscriptions: 1,000 shares common $100,000 1,000 shares preferred 100,000 Ch. 27] COMBINATION BY MERGER OR PURCHASE 1293 Mitchell & Stevens, Bankers $900,000 Discount on Bonds 100,000 To Unissued Bonds $1,000,000 For sale of $1,000,000 par of bonds to hankers at 90, payable one-third down and one-third each three months. Cash $300,000 To Mitchell & Stevens, Bankers ju/f $300,000 First payment of one-third on account of bond sale. Cash $500,000 To Unissued Preferred Stock .'.... $500,000 For sale of $500,000 par of preferred stock to Bell Brothers & Company, bankers. Full payment received in cash ; 50% bonus of common stock given as entered below. Donated Capital $250,000 To Treasury Stock $250,000 Bonus of common stock given to Bell Brothers & Company, being 50% of cash sale of $500,000 of preferred stock. 281. (5) Entry in Settlement of Intercompany Obligations The following entry in settlement of intercompany obligations would be made as soon as the Bain plant is in a position to spare the cash. This indebtedness could have been, and usually is, settled before making the transfer; otherwise it could be included in the regular personal accounts. Cash $101,000 To Due from Bain Company $101,000 To settle claims owing by the Bain Company at time of amalgamation, and which were carried into the accounts of this Company as follows: Owing to Long Company $85,000 Owing to Bell & Davis 16,000 There is nothing special to be done with the sinking fund at this time, and it will stand on the books of the new corporation as it formerly stood on the books cf the Long Company, until additional instalments are deposited therein. All interest ac- 1 294 CORPORATE ACCOUNTING [Bk. HI- cumulations thereon must of course be added from time to time as they are reported by the trustee. In anticipation of the bond redemption at 105, the company is to begin, on January i, 1925, to set aside out of profits an an- nual reserve of $6,000 to offset bond premium, which may be credited to Reserve for Bond Premium. When the bonds are called at a premium, such premium is charged against the reserve. 282. Closing Books of Dissolving Companies There are two main systems of conducting branch houses: in the first, all accounts are kept in the books of the home office and all collections are made therefrom, all business trans- acted at the branches being reported daily to the home office ; in the other, all accounts and records are kept at the branch offices and reports are made to the home office from time to time. As all the assets and liabilities of the Vine Company and of Bell & Davis have been transferred to the home office books, it may be assumed that these branch offices are to be handled under the first plan practically as selling agencies. It is evident that the Bain plant is to be handled under the second plan, the assets and liabilities being continued in its own ledgers, and its own complete set of books being maintained as before. There- fore, any adjustments necessary in the transfer of ownership and liquidation of certain liabilities must necessarily be made in these books. This branch will keep all accounts pertaining to its busi- ness affairs and report periodically to the home office. The entries required on the books of Long Company to show its final distribution and dissolution are shown in Chapter XXVIII. Similar adjusting and closing entries are required on the books of the Vine Company, setting up the necessary accounts for clearing the transaction and distributing the newly acquired stock. Closing entries for Bell & Davis are similar to those given in 158-161. Since the operating accounts of the Bain Company are to remain on the books of the branch, it is Ch. 27] COMBINATION BY MERGER OR PURCHASE I2 95 manifest that only certain adjusting entries are necessary at this time. These also are shown in Chapter XXVIII. 283. Balance Sheet of New Corporation The balance sheet which follows is practically a trial balance of the ledger accounts after the incorporation of the new com- pany. BALANCE SHEET OF THE LONG-BAIN MANUFACTURING COMPANY As or JANUARY i, 1922 (After incorporation and merging) Assets Cash $ 1,228,700 523,700 1,266,50x3 59,400 5,304,500 560,000 1,305,100 195,300 161,000 674,500 4,950,000 740,000 225,000 100,000 220,000 925,000 200,000 700,000 600,000 3,518,200 Liabilities and Caf Notes Payable rital $ 910,100 757,7oo 52,300 399,100 12,200 105,500 220,000 5,000,000 8,000,000 8,000,000 Notes Receivable Accounts Payable Accounts Receivable. . . . Prepaid Charges Accrued Charges Reserve for Depreciation. Reserve f'or Bad Debts.. . Reserve for Insurance . . . Donated Capital . . Investments : Bain Branch Plant. . . . Stock of Other Com- panies Stock and Material First Mortgage Bonds . . . Authorized Capital Stock Preferred . . . Supplies Furniture and Fixtures.. . Patents, Patterns, and Tools Authorized Capital Stock Common . Buildings and Plant Sinking Fund Trustee . . . Incorporation Expenses. . Discount on Bonds Treasury Stock Unissued Bonds Unissued Preferred Stock Unissued Common Stock . Mitchell & Stevens, Bankers Good-Will* $23,456,900 523,456,900 * Comprising the good-will of the Long Company, the Vine Company, and of Bell & Davis. The good-will of the Bain Company is included in the account of the Bain branch plant, shown under "Investments." Part VI Dissolution, Reorganization, Receivership CHAPTER XXVIII VOLUNTARY DISSOLUTION OF CORPORATIONS 284. Introductory In most of the states a corporation may be dissolved by its stockholders, the procedure being simple; and while in some states unanimous consent is required, in others two-thirds, three-fourths, or even a bare majority is enough to terminate the corporate existence. Many of the smaller corporations end their existence in- formally by failure to pay taxes or to make corporate reports, in consequence of which the state forfeits the charters under which they operate. In case of voluntary dissolution, the directors are the trustees authorized to settle the company's affairs, and they may bring this about in the simplest manner possible. The chief difficulty, however, lies in collecting outstanding accounts, and in disposing of properties without too great sacrifice. 285. Entries for Dissolution Theoretically the entries for the dissolution of a corporation are very simple. Assume for illustration the case of a corpora- tion with tangible assets of a book value of $50,000, liabilities of $15,000, capital stock of $20,000, and a surplus of $15,000. This corporation decides to realize on its assets, pay its debts, and dis solve. It sells the assets for $45,000, pays sale and dissolution 1297 1298 CORPORATE ACCOUNTING |Bk. III- expenses of $2,000, and liquidates its liabilities of $15,000, so that it has $28,000 in cash remaining. This is divided among the stockholders, and then, by following the prescribed statutory procedure, the corporation is dissolved. As the assets are sold Cash is debited and the asset accounts are credited, any profit realized or loss sustained by selling above or below the book values being carried to Surplus. As the debts are paid, Cash is credited and the proper liability accounts debited. The trial balance of the books just before dissolution (all income and expense accounts having been closed into Surplus) will be as follows: Cash $28,000 Surplus $ 8,000 Capital Stock 20,000 ) . t y// $28,000 $28,000 The books are then closed by the entry: Surplus $ 8,000 Capital Stock 20,000 To Cash $28,000 To record distribution of the company's assets prior to its dissolution. Complications may develop in the entries having to do with the realization and liquidation, but the above method will always apply. The liquidation of liabilities may proceed as fast as cash becomes available. 286. Profit or Loss on Realization The profit or loss resulting from the sale of the assets may be handled in any one of several ways. A method which requires the opening of no new accounts is illustrated by the following example. Land which cost $42,000 and is carried on the books at that figure, brings $51,000. The gain is credited to Profit and Loss, the entry for the sale being: Ch. 28] VOLUNTARY DISSOLUTION 1299 Cash $51,000 To Land $42,000 Profit and Loss 9,000 (Full explanation here.) Another way of handling the transaction is to credit such gains or debit such losses to an account known as "Loss and Gain on Realization," in order that the results of the realization may be separately accumulated on the books. This account will ulti- mately be closed into the regular Profit and Loss account, or else directly into Surplus. 287. Sale of Business as a Going Concern The simplest case of realization arises when a business is sold as a going concern, i.e., when the assets, including good- will and trade-name, are sold as a whole to another person or corporation. The purchaser may or may not assume the liabilities. As an example of the sale of a going business we shall consider the case of the Long Company, whose assets have been purchased and whose liabilities have been assumed by the Long-Bain Manufacturing Company for $4,000,0x50 of the common and $4,000,000 of the preferred stock of the latter company. It was agreed, however, that the Long Company should donate back to the purchasing company $400,000 of the common stock to be sold to provide working capital for the new company. The transactions leading up to this sale have been discussed in the preceding chapter, where the trial balance of the Long Com- pany is shown. The following is a summary of that trial balance, showing the assets and liabilities of the Long Company as they appear in its books at the time of sale. Tangible Assets '. $ 9 ,410,300 Good-Will 1,000,000 Total Assets $10,410,300 Liabilities 4,263,500 Net Worth $6,146,800 1300 CORPORATE ACCOUNTING [Hk. IT1- 288. Adjusting Entries for Long Company In the purchase agreement it was stipulated that the Long Company should first reduce its liabilities (and its assets) by paying off a dividend due in the amount of $230,000. This pay- ment gives rise to the first entry necessary on the books of the Long Company, as follows : First Entry: Dividend Payable $230,000 To Cash $230,000 For payment of dividend due today. Since the Long Company is to receive $8,000,000 in stock for its net assets of $6,146,800, it becomes evident that the differ- ence of $1,853,200 is the price being paid for its good- will above the $1,000,000 at which good-will is carried on its books. This additional value will be set up on the Long Company books by the following entry : ' / > t ' t Second Entry: Good-Will $1,853,200 To Surplus $1,853,200 This Company has agreed to sell out to the Long-Bain Manufacturing Company for $8,000,000, as per agree- ment executed this day in accordance with the order of the Board of Directors. Since the net worth of this company by its books is $6,146,500 and the sale price of the net assets is $8,000,000, additional good- will of $1,853,200 must be set up. 289. Transfer of Assets and Liabilities It is now necessary to record the transfer of the assets and liabilities under the agreement with the Long-Bain Manufactur- ing Company, and to show that company's payment therefor in stock. This is accomplished by the following entries : Third Entry: Long-Bain Manufacturing Company $12,033,500 To Cash $ 342,800 Notes Receivable 340,600 Accounts Receivable 1,021,300 Ch. 28] VOLUNTARY DISSOLUTION 1301 Prepaid Charges $ 46, 200 Investments 500,000 Stock and Material 964,300 Supplies 175,100 Due from Bain Company 85,000 Furniture and Fixtures 125,000 Patents, Patterns, and Tools 450,000 Building and Plant 4,390,000 Sinking Fund 740,000 Good-Will 2,853,200 l-'or all assets turned over in payment of subscription to $8,000,000 of stock, as per resolution of the directors and stockholders. Fourth Entry: Notes Payable $ 685,000 Accounts Payable 350,000 Accrued Charges 37>9o Reserve for Depreciation 345,100 Reserve for Bad Debts 10,000 Reserve for Insurance 105,500 First Mortgage Bonds 2,500,000 To Long-Bain Manufacturing Company - $4,033,500 For all liabilities of Long Company assumed. Fifth Entry: Stock of Long-Bain Manufacturing Company $8,000,000 To Long-Bain Manufacturing Company $8,000,000 For $8,000,000 of the capital stock of the Long-Bain Manufacturing Company received this day, as per agreement, in full payment for plant, assets, and liabilities turned over and transferred according to legal requirements: 40,000 shares common stock $4,000,000 40,000 shares preferred stock 4,000,000 $8,000,000 290. Final Entries of Long Company A trial balance of the books of the Long Company at this point would show the following figures: Stock of Long-Bain Manufacturing Company $8,000,000 Capital Stock $5,000,000 Surplus 3,000,000 1302 CORPORATE ACCOUNTING [Bk. m- The company has now no further functions to perform except to distribute its assets. First, $400,000 of the stock of the Long- Bam Manufacturing Company is to be donated back to that company. After this is done the remainder may be divided among the stockholders. The following entries will show the transactions : Sixth Entry: Surplus $400,000 To Stock of Long-Bain Manufacturing Company. . $400,000 For donation of 10% of the allotment of $4,000,000 common stock, to be used by the Long-Bain Com- pany for working purposes Seventh Entry: Capital Stock $5,000,000 Surplus 2,600,000 To Sundry Stockholders $7,600,000 For allotment of stock of the Long-Bain Company to the individual stockholders in proportion to holdings. The distribution of stock must of course be made in the pro- portion decided upon by the stockholders themselves, and it is evident that uneven amounts of both classes of stock will obtain. In some cases, to make an equitable adjustment, money will have to be passed for the equalization of shares. Eighth Entry: Sundry Stockholders $7,600,000 To Stock of Long-Bain Manufacturing Company. . . $7,600,000 For distribution of the common and preferred stock of the above company in accordance with allotment agreement. There is now no balance in any account on the books of the Long Company. 291. When Asset and Liability Accounts Are Not Closed It sometimes happens that the successor business desires to take over and continue the use of the books as they stand, and does not wish the asset and liability balances closed out. Assume Ch. 28] VOLUNTARY DISSOLUTION 1303 that the corporation which we took for an example in 285, instead of attempting to sell its assets piecemeal, sold as a going concern for $40,000 cash. The purchaser is the New Corpora- tion, organized with a capitalization of $50,000, fully paid in cash. The New Corporation does not wish the asset and liability accounts closed, as it wishes to use the same books. Ordinarily, of course, the entries for the incorporation and opening transactions of such a corporation would be as follows: Cash $50,000 To Capital Stock $50,000 Asset Accounts (separated) $50,000 Good-Will 5,ooo To Liability Accounts (separated) $15,000 Cash 40,000 The showing of good-will results from the fact that net tangible assets of a value of $35,000 were purchased for $40,000. In this case, however, the asset and liability accounts (except Good- Will) are already on the books, exactly offset by the net worth accounts of the dissolving corporation. It is desired to close out the latter group instead of the asset and liability ac- counts, and at the same time to set up the good-will and to show the organization of the New Corporation. All of this may be done in one entry, as follows: Good-Will $ 5,000 Surplus 15,000 Capital Stock 20,000 Cash 10,000 To Capital Stock New Corporation $50,000 Recording the purchase of the net assets of this corporation for $40,000 cash paid by the New Corporation; recording also the distribution of that $40,000 to the stockholders of this Company prior to its dissolution; setting up on the books the $5,000 paid for the good-will of the company above the value of its net assets; and closing its Capital Stock and Surplus accounts in favor of the New Corpora- tion, whose authorized stock is fully paid and issued as as follows: (Insert list] 1304 CORPORATE ACCOUNTING [Bk. III- 292. Adjustments of the Bain Company A more complicated case of the same kind is that of the entries for the dissolution of the Bain Company, which merged with the Long Company to form the Long-Bain Manufacturing Company. The trial balance of this company's books is presented in the pre- ceding chapter, and need not be repeated here. The fulfilling of the conditions of the sale of the net assets of this company is shown in the following entries, the explanatory notes in connec- tion with which will present all needed details. In the first place, as in the case of the Long Company (whose closing entries were given in 287 Jf.), the Bain Company is to receive for its net assets stock in excess of their book value. This excess is the purchase price of the good- will of the Bain Company and is placed upon the books in the following entry : Good-Will $1,020,000 To Surplus $1,020,000 For sale value of plant and net worth in excess of present book value. (Full explanation here.} The Bain Company is also to reduce its liabilities (and of course its assets at the same time) by paying off a dividend and certain secured notes which it owes. The entry of these pay- ments and of the return of the securities pledged as collateral for the loan is shown in the following entries : Dividend Payable $105,000 To Cash $105,000 For payment of dividend due today. Secured Loans $100,000 To Cash $100,000 For payment of secured loans. Investments $i 20.000 To Pledged Securities $120,000 For return of pledged securities upon payment of loan. 293. Dissolution of the Bain Company The above entries present nothing unusual. The entries for the dissolution of the Bain Company differ from those of the Long Ch. 28] VOLUNTARY DISSOLUTION 1305 Company, however, because the Bain Company's office is to be maintained as a branch office for the Long-Bain Manufacturing Company, which therefore does not wish the asset and liability balances closed out. The net worth accounts of the Bain Com- pany must be taken off the books and in their place must be sub- stituted the investment of Long-Bain Manufacturing Company in the branch. The entries may be made as follows: Stock of Long-Bain Manufacturing Company. $5,000,000 To Long-Bain Manufacturing Company $5,000,000 For common and preferred stock of the Long-Bain Company received in full payment for plant, assets, and liabilities: 25,000 shares common $2,500,000 25,000 shares preferred 2,500,000 Surplus $250,000 To Stock of Long-Bain Manufacturing Company . . $250,000 For donation of 2,500 shares common stock back to the , Long-Bain Company for working purposes. Capital Stock $3,500,000 Surplus 1,250,000 To Sundry Stockholders $4,750,000 For allotment of stock in the new corporation, in pro- , portion to holdings. Sundry Stockholders $4,750,000 To Stock of Long- Bain Manufacturing Company. . . $4,750,000 For distribution of stock, as per agreement of adjust- ments. 294. Balance Sheet of the Bain Company After Adjustment The Long-Bain Manufacturing Company then exchanges its own bonds for the mortgage note owing by the Bain Company. Mortgage Payable $300,000 Interest Accrued 4,500 To Long-Bain Manufacturing Company (Home Office) $304,500 For payment of mortgage and accrued interest by the Long-Bain Company by an equivalent exchange of 5% bonds. 1306 CORPORATE ACCOUNTING [Bk. III- The following balance sheet of the accounts as shown on the books of the Bain branch after all the above adjustments have been made, is given to show how the net worth accounts have disappeared in favor of the proprietorship interest of $5,304,500 standing to the credit of the Long-Bain Manufacturing Com- pany. Certain of the assets could, with some advantage, be transferred to the home office books and removed from the branch ledger, such as the investments, buildings and plant (particularly the real estate). Depreciation reserve and good- will might also be transferred. This would leave only working accounts on the branch ledger, and a credit of $776,000 to the home office. The entries must of course suit the conditions. BALANCE SHEET OF THE BAIN BRANCH (After sale to the Long-Sain Company, showing open ledger accounts ) Assets Cash $ 67,500 Notes Receivable 135,800 Accounts Receivable 492,750 Prepaid Charges 38,150 Investments. . . , 270,000 Stock and Material 510,000 Supplies 51,900 Furniture and Fixtures. . . . 62,000 Patents, Patterns, and Tools 244,850 Buildings and Plant 3,359,000 Good- Will 1,020,000 $6,251,950 Liabilities Notes Payable $ 270,000 Accounts Payable 540,000 Accrued Charges 11,640 Reserve for Depreciation . . . 120,500 Reserve for Bad Debts. . . . 5.3 JO Long-Bain Company Home Office Account 5,304,500 $6,251,950 CHAPTER XXIX REORGANIZATION BY AGREEMENT 295. Definition of Reorganization "A reorganization of a corporation is a business arrangement (i) whereby the stocks and bonds of the company are rearranged as to amount, income, or priority, or (2) the property is sold to a new corporation for new stock and bonds, or (3) the property is sold by foreclosure of a mortgage upon it, and the purchaser buys for himself and such of the old stockholders and bondhold- ers as he associates with him." 1 Any material change in the ownership of the stock is usually accompanied by at least a partial reorganization. 296. Methods of Reorganization According to the definition there are two kinds of reorganiza- tion by agreement. The first is a mere readjustment of the rights of the various parties interested, i.e., by the stockholders with the co-operation of -the bondholders or other creditors, without forming a new corporation. The problems given in this chapter relate to such readjustments. The second involves the formation of a new corporation and the voluntary sale of all the property of the old corporation to it in return for its stocks and bonds. The accounting prob- lems connected with this method of reorganization are essen- tially similar to those of consolidation by merger and by pur- chase. 2 Both of these methods are called reorganizations by agree- 1 Cook, on Corp., { 883. * See Ch. XXVII, "Combination by Merger or Purchase." 1307 1308 CORPORATE ACCOUNTING [Bk. III- ment, in contradistinction to reorganizations as the result of legal compulsion where the corporation is insolvent and its prop- erty may be sold to pay off the bondholders and creditors. When the property of a corporation is sold under foreclosure proceedings, the entity of the corporation does not pass. What- ever organization is effected by the purchaser to operate the plant, property, or business taken over, is practically a new or- ganization free from all claim or liability of the old corporation. The accounting problems relating to it are similar to the prob- lems involved in opening the records of a new corporation. Reorganization as the result of a receivership is discussed in the following chapter. / ; in! ;i /";' 'jlij. ', ){'!. A >' 297. Reorganization by Reduction of Stock A reorganization by agreement may involve some readjust- ment of the amount of the stock and bonds of the reorganized company. A reduction of capital stock is not as simple as an increase, because in reducing stock the rights of creditors must be considered, and the surrender of outstanding stock and the issuance of a less number of shares involve some cancellation and reissue of stock to existing stockholders. As an illustration of the procedure and book records required for reducing the capital stock of a corporation, the following example is given: The Harkness Automobile Company,' whose statement is given below, was formed by the merger of several automobile concerns. At the time of the combination, good- will was placed at $1,000,000 and surplus at $340,000. Since then regular divi- dends of 7% on preferred and 5% on common stock have been paid, excepting the one recently declared and shown among the liabilities. An audit of the books made for the year ending June 30, 1921, showed that obsolete properties, doubtful accounts, and valueless investments to the amount of approximately $i,- 000,000 would have to be written off. The following statement was submitted by the accountants with the recommendation that the good- will be reduced to a conservative valuation: Ch. 29] REORGANIZATION BY AGREEMENT HARKNESS AUTOMOBILE COMPANY AND BRANCHES BALANCE SHEET, JUNE 30, 1921 (Before reduction of capital) 1309 Assets Cost of Properties and Equipment, including Liabilities Capital Stock: Preferred $ 1,000,000 Good-Will $ 4,500,0x30 Common 3,000,000 Securities Owned, of Sub- Bonds Outstanding 2,500,000 sidiary and Other Com- Short-Term Notes 500,000 panies 1,300,000 Accounts Payable i.J bh-< Merchandise Sales $287,680 To Cost of Sales $218,200 Profit and Loss 69,480 Closing merchandising accounts and showing gross profit on sales. Recoveries on Doubtful Receivables $75,000 To Profit and Loss $75,000 Closing former account to show gain on realiza tion over appraised value of assets. Profit and Loss $157,000 To Discount on Receiver's Certificates $24,000 Expenses 76,500 Salary of Receiver 10,000 Legal Expenses 22,500 Interest on Receiver's Certificates 24,000 Closing expense .accounts. Excelsior Harvester Company $12,520 To Profit and Loss $12,520 Charging the net loss of period against the value taken over by the receiver. 1322 CORPORATE ACCOUNTING [Bk. IH- Allowance for Doubtful Receivables $ 422,140 Claims Allowed. . 4,673,290 Excelsior Harvester Company 10,354,230 To Real Estate, Plant, etc $6,935,190 Merchandise Inventory 2,150,000 Accounts Receivable 1,520,700 Notes Receivable. 1,841,220 Cash on Hand and in Banks 3,002,550 Closing the books of the receiver and showing the assets and liabilities turned back to Excelsior Harvester Company. 311. Receiver's Statement to the Court The receiver may present to the court only one account or statement, known as the "first and final account," or he may present several. An auditor is usually appointed by the court to audit, examine, vouch, and pass upon the receiver's accounts in detail and to report to the court before distributions are made, or dividends paid to creditors. The auditor causes an advertisement to be placed in the papers, giving notice that he will sit on a certain date to receive claims and hear complaints on the audited statement. The hearing may even be adjourned one or more times. The auditor generally makes up a statement of his own from that presented by the receiver, though it is usually briefer and may even be only a summary of the receiver's transactions. It recites in brief, as a rule, the activities of the receiver as an introduction to the audited statement, all of which is later filed with the court, to be kept as a permanent record. The following is usually a satisfactory form for the general statement of account rendered by the receiver, but it should be remembered that some of the states have specific forms estab- lished by statute which are required to be filled out. Persons dealing with particular judges in matters having to do with several receiverships learn, too, that some one form is more satisfactory to a certain judge than is another form, and that the favor of the court can best be secured by submitting the report in a form most intelligible to and best liked by that judge. Ch. 30] RECEIVERSHIP AND REORGANIZATION 1323 FIRST AND FINAL ACCOUNT OF THE RECEIVER FOR EXCELSIOR HARVESTER COMPANY DECEMBER 3 1, 1921 Debits THE RECEIVER CHARGES HIMSELF AS FOLLOWS: Inventory and Appraisement of Assets taken over July i, 1921: Equity in Real Estate, Plant, etc $6,435,190 Equity in Investments of Subsidiary Companies (none) Merchandise Inventory 2,100,000 Accounts Receivable 3,200,000 Notes Receivable 2,440,100 Cash on Hand and in Banks 945,850 Total Assets taken over $15,121,140 Additions to Capital: For Outlay Increasing Value of Real Estate and Prop- erties $ 500,000 Increase in Cash, per Cash Account. 2,056,700 Increase in Value of Merchandise 50,000 Total Increase in Assets 2.606,700 Total Debits $17,727,840 Credits THE RECEIVER CREDITS HIMSELF AS FOLLOWS: Claims Allowed and Not Paid, as per schedule $4,673,290 Assets Realized and Collected as Follows: Accounts Receivable Collected $1,724,440 Notes Receivable Collected 975,880 Total Realization 2,700,320 Total Credits 7.373,6io Present Accountability $10,354,230 This general statement must be supported by exhibits and schedules, among which will usually be found a balance sheet, a 1324 CORPORATE ACCOUNTING [Bk. Ill- statement of profit and loss from operations (in this case trading) , a summary of the cash account, and lists of claims allowed but not paid and of claims allowed and paid. Satisfactory forms for the more important of these are presented in the following sections and in the next chapter. 312. Statement of Affairs at Termination of Receivership As a result of all his transactions, the receiver's balance sheet at the time of closing will appear as follows : FINANCIAL STATEMENT OF RECEIVER FOR EXCELSIOR HARVESTER COMPANY AT TERMINATION OF RECEIVERSHIP JURISDICTION, DECEMBER 31, 1921 Assets Real Estate, Plant, etc $12,036,500 Less: Reserve for Depreciation . 897,5 10 __ ' ' $11,138,990 Less: First Mortgage Bonds $6,500,000 Reduced by: Cash and Bonds in hands of Trustee 2,296,200 4,203,800 Receiver's Equity $ 6,935,190 Investments of Affiliated Companies $ 4,000,000 Less: Collateral Trust Bonds Secured thereby. 4,000,000 Receiver's Equity (none) Merchandise Inventory. 2,150,000 Accounts Receivable 1,475,560 Notes Receivable * 1,464,220 Cash on Hand and in Banks 3,002,550 Total $15,027,520 Liabilities Bank Loans Unsecured $ 500,000 Notes Payable 1,490,500 * Notes under discount at bank, $400,000 additional. Ch. 30] RECEIVERSHIP AND REORGANIZATION 1325 Accounts Payable 2,375,640 Accrued Charges 247,150 Claims on Notes under Discount ." 60,000 Total Liabilities 4,673,290 Receiver's Equity, Excess of Assets over Liabilities . . $10,354,230 313. Other Exhibits and Schedules The statement of profit and loss and the lists of claims need not be given here, as they present no unusual difficulties. The summary of the cash account may be in the form given in 308, or the opening balance and later receipts may be listed at the top of the page and the disbursements at the bottom, the total of the latter being subtracted from the total of the former to obtain the closing balance. A schedule which it is always wise to append is an analysis of the receiver's equity, or his account with the company for which he is acting as receiver. This acts hi a way as a recon- ciliation of certain supporting schedules with the balance sheet, and may be in the following form : ANALYSIS OF RECEIVER'S EQUITY . Equity at beginning of receivership $15,121,14; Loss from operations $ 12,520 Claims allowed . . urB' )r 4, 754,39 Total deductions. .... . P. ? J: . '. 4,766,910 Equity at termination of receivership $10,354,230 314. Adjustment of Company's Books on Appointment of Receiver The books of the embarrassed company are frequently left in the condition that prevailed when the receivership began. In that case no entries of any kind are made until the time of reor- ganization, when the abandoned accounts may be adjusted to the 1326 CORPORATE ACCOUNTING [Bk. Ill- new conditions. Sometimes it may be thought advisable, how- ever, to adjust the accounts at both the beginning and end of receivership jurisdiction. This is assumed to have been done with the books of the Excelsior Harvester Company. By referring to the appraisement, it will be seen that numer- ous adjustments of values were made. The losses sustained thereby should be adjusted into Surplus account in order to bring the ledger into agreement with the property valuations taken over by the receiver. 315. Entries to Adjust Asset Values Shrinkages in asset values as shown by the appraisement are adjusted through the following entry on the books of the com- pany: July i, 1921 Surplus $1,736,100 To Real Estate, Plant, etc. .....'. .'M .IV. ; '/. . .... $600,000 Investments 500,000 Merchandise, etc 78,960 Accounts Receivable 45. M Notes Receivable 422,000 Cash 30,000 Notes under Discount 60,000 To adjust losses and shrinkage in assets, per appraise- ment of receiver. It will be seen that this adjustment reduces the surplus of the company from $2,io2,85o 6 to $366,750, which with the capital stock of $1,000,000 makes up the net worth of $1,366,750 shown in the appraisal. Closing entries should then be made, charging the receiver with the equity in the assets taken over, as follows: July i, 1921 Receiver $15,121,140 To Real Estate, Plant, etc $6,435,19 Merchandise Inventory 2,100,000 * As shown in 5 303. Ch. 30] RECEIVERSHIP AND REORGANIZATION 1327 Accounts Receivable Notes Receivable Cash on Hand and in Banks To record transfer of Company's assets to the receiver, as per order of the Court. 3,200,000 2,440,100 945,850 The receiver's account in the company's ledger now shows a debit balance of $15,121,140, corresponding with the amount of his account with the company in the receiver's ledger. The company's accounts after transferring the assets to the receiver appear as follows: TRIAL BALANCE, JULY i, 1921 Receiver $15,121,140 Real Estate, Plant, etc 5,101,310 Sinking Fund Investments 2,000,000 Sinking Fund Cash 296,200 Investments in Affiliated Companies 4,000,000 Reserve for Depreciation $ 897,510 First Mortgage Bonds Outstanding 6,500,000 Collateral Trust Bonds Outstanding 4,000,000 Bank Loans Unsecured 500,000 Notes Payable 1,490,500 Accounts Payable .-...> 2,375,640 Accrued Charges 328,250 Notes under Discount 60,000 Capital Stock Preferred 5,000,000 Capital Stock Common 5,000,000 Surplus 366,750 $26,518,650 $26,518,650 316. Entry of Claims Approved by the Receiver Under the above plan the liabilities are not credited to the receiver on the company's books. It is, however, usually thought advisable to credit him with them as he reports to the court that he has approved the claims, thus keeping the com- pany's account with the receiver in accord with the receiver's account with the company. Such an entry would be in the following form: 1328 CORPORATE ACCOUNTING [Bk. Ill- Bank Loans Unsecured $ 500,0x30 Notes Payable 1,490,500 Accounts Payable 2,375,640 Accrued Charges 328,250 Notes under Discount 60,000 To Receiver $4,754,390 Crediting receiver with claims allowed by him and closing those accounts on the Company's books. After the liabilities have been credited to the receiver's ac- count, entry will be made of claims paid by the receiver until the assets and liabilities are taken back on the company's books. 317. Entry of Receiver's Profit or Loss In order to preserve the completeness of the company's own records, it is good practice to enter on the company's books the gain or loss shown by each report approved by the court, so that following each such report the Receiver account on the com- pany's books will still equal the amount shown by the receiver's account with the company. This entry would be taken from his operating statement, and in the present instance would be as follows : Discount on Receiver's Certificates $ 24,000 Cost of Sales 218,200 Expenses 76,500 Salary of Receiver 10,000 Legal Expenses 22,500 Interest on Receiver's Certificates 24,000 To Merchandise Sales $287,680 Recoveries on Doubtful Receivables 75.ooo Receiver 1 2,520 Recording operations of the receiver and crediting his account with the loss sustained. Entries of this type would be allowed to accumulate on the books until the close of the corporation's fiscal period, or such other tune as it seemed desirable to close the books, when the income and expense accounts so opened would be closed into Profit and Loss and that account into Surplus. In the present Ch. 30] RECEIVERSHIP AND REORGANIZATION 1329 instance, of course, if the company's ordinary book-closing date is December 31, the entry made above would be immediately reversed, except that the $12,520 credited to the receiver in the entry would in the reversal be debited to the Profit and Loss account. 318. Entry at Close of Receivership It is not ordinarily advisable for the rompany to take the assets back into its ledger accounts until the reorganization takes place. At that time the various adjustments should of course be made in order to reopen the ledger in harmony with the reorganized conditions. If it is thought desirable, however, to take the assets and liabilities as shown by the receiver's final statement into the company's ledger accounts, with the idea of making reorganization adjustments later, the journal entry would be : Real Estate, Plant, etc $7,832,700 Merchandise Inventory 2,150,000 Accounts Receivable 1,475,560 Notes Receivable 1,464,220 Cash 3,002,550 To Bank Loans Unsecured $ 500,000 Notes Payable 1,490,500 Accounts Payable 2,375,640 Accrued Charges 247,150 Reserve for Depreciation 897,510 Notes under Discount 60,000 Receiver 10,354,230 To record existing assets and liabilities on books of the Company on termination of receivership (preceding the reorganization adjustments). The Surplus account now shows a credit balance of $354,230, thus indicating a heavy shrinkage as a result of the receivership and its resulting destruction of values. After the reorganization takes place, these ledger accounts will of course be readjusted to harmonize with the new conditions as adopted by the committee of reorganization. 1330 CORPORATE ACCOUNTING [Bk. III- In the case of railways and public utilities, there is good reason for keeping the company's books continuously during the re- ceivership regardless of the receiver's records, since it is usually a foregone conclusion that, because of their necessary service to the community, they will continue operations as usual, both during and subsequent to the receivership jurisdiction. CHAPTER XXXI RECEIVERSHIP AND SALE 319. Introductory Reorganization following the appointment of a recei yer and the necessary accounting procedure have been set forth in the preceding chapter. If, as may happen, a reorganization cannot be effected, it becomes the duty of the receiver to sell sufficient of the property to pay, first, the expenses of the receivership and sale, and second, the creditors of the corporation. He is not required to sell all the assets if the sale of only a part will place the corporation in a solvent condition. If he does not sell all the assets, the remainder will revert to the corporation, or if any cash remains from the proceeds of those he does sell, the corporation will be entitled to it. In the example which is presented the same general prin- ciples which were set forth in the preceding chapter will of course apply, but in order to present another method of handling the transactions it will be assumed in this case that the receiver makes his entries on the books of the bankrupt company instead of opening a new set. 320. Statement of Affairs The Willis Grocery Company was placed in the hands of a receiver on April i, 1922, at the request of creditors. William Hart was appointed receiver with full authority to continue the business under court supervision and to conserve the company's property, in the hope of effecting a favorable settlement with the creditors. Following is the statement of affairs prepared by the receiver; 1331 1332 CORPORATE ACCOUNTING [Bk. III- STATEMENT OF AJFAIRS WILLIS GROCERY COMPANY WILLIAM HART, RECEIVER APRIL i, 1922 Appraised Shrink- Assets Book Values Values age Buildings and Properties $50,000 Less: Mortgage 25,000 Company's Equity $ 25,000 $ 18,800 $ 6,200 Store Equipment 10,000 8,000 2,000 Delivery Equipment 10,000 8,000 2,000 Merchandise. ..!......! .' ' 75,600 65,600 10,000 Produce .-^.H 11,850 9,850 2,000 Accounts Receivable 85,410 81,140 4,270 Notes Receivable 12,500 10,700 1,800 Bonds of Other Corporations, Pledged. . $25,000 Less: Liability thereon 10,000 Company's Equity . 15,000 12,000 3,000 Cash 5,820 5,820 $251,180 $219,910 $31,270 General Liabilities Book Values Claims Mortgage Note on Real Estate $ 25,000 Deducted Contra 25,000 Notes Payable Secured $ 10,000 Deducted Contra 10,000 Notes Payable Unsecured $ 15,000 $ 15,000 Accounts Payable 91,460 91,460 Capital Stock $150,000 Less: Deficit 5,280 Net Worth 144,720 113,450 $251,180 $219,910 Ch. 31] RECEIVERSHIP AND SALE 321. Receiver's Entries on Taking Charge The receiver plans in this case to record his operations on the books of account used previously by the Willis Grocery Com- pany. Under these conditions his official transactions are entered up as would be any ordinary business. The adjusting entries to harmonize the balances in the accounts with the revised statement of conditions are given below. The plan fol- lowed in this instance might not apply in every case, but it is simple and can be readily understood. It will be noted that when the receiver continues to use the corporation's books the liabilities all show from the first. April i, 1922 Surplus and Deficit. .....: $31,270 To Merchandise $10,000 Produce 2,000 Accounts Receivable 4,270 Notes Receivable 1,800 Buildings and Properties 6,200 Store Equipment 2,000 Delivery Equipment 2,000 Bonds of Other Corporations 3iOoo To record the shrinkage in asset values as shown by ap- praisal, and to harmonize the balances in the accounts with the receiver's statement of affairs. The ledger now shows an impairment or deficit of $36,550. With an outstanding capital of $150,000, this leaves an equity of only $113,450. The Capital Stock and Surplus and Deficit accounts should not appear in the receiver's ledger at all, and therefore are closed out by journal entry, leaving instead a credit balance of $113,450 to Willis Grocery Company account. The required journal entry would be as follows: April i, 1922 Capital Stock $150,000 To Surplus and Deficit $ 36,550 Willis Grocery Company 1 13,450 To close the Capital Stock and Surplus and Deficit ac- counts and to open Willis Grocery Company account to show the receiver's equity. 1334 CORPORATE ACCOUNTING [Bk. IIT- 322. Entries to Record Operation under Receivership The receiver, after complying with all legal requirements, continued the business for five months in an effort to put the company on its feet, but without success. His transactions up to September i are shown below. At that date the receiver reported to the court his inability to make the business suc- cessful. The recording of the receiver's activities would be made in the cash book and journal. The cash book entries are sum- marized in the Cash account given below and the closing journal entries follow: RECEIVER'S CASH ACCOUNT APRIL i TO SEPTEMBER i, 1922 Receipts Balance taken over April i, 1922 $ 5,820 Notes Receivable 5,5o Accounts Receivable 22,640 Sales of Merchandise 53,75 Sales of Produce 24,800 Disbursements Merchandise Purchases $ 9,620 Produce Purchases 13,110 Payment of Wages 4,000 Operating Expenses 4,500 Expenses and Salary of Receiver 1,500 Total $ 32,73 Balance in Hands of Receiver 79,780 $112,510 CLOSING JOURNAL ENTRIES September i, 1922 Produce Sales; $24,800 Merchandise Sales 53i75o To Produce Purchases Merchandise Purchases ; .Um: ; Profit and Loss . wvn - Recording gross profit on sales of produce and merchandise and reducing Purchases accounts to present inventory values. $112,510 $20,460 53.220 4,870 Ch. 31] RECEIVERSHIP AND SALE 1335 Profit and Loss $10,000 To Wages $4,000 Expenses 4.500 Receivership Expenses iiSoo To close above accounts into Profit and Loss. Willis' Grocery Company $ 5,130 To Profit and Loss . . $ 5, 130 To close Profit and Loss account into Willis Grocery Com- pany account. 323. Receiver's Statement before Sale The posting of the entries above furnishes the figures for the following statement as of September i, 1922. This statement of affairs, when presented to the court, would probably be supported by schedules of the transactions .of the receiver ( 333 $-) or the court might not wish these until the receiver was ready to render his final report. STATEMENT OF AFFAIRS WILLIS GROCERY COMPANY WILLIAM HART, RECEIVER SEPTEMBER i, 1922 Assets Buildings and Properties $43,800 Less: Mortgage Thereon 25,000 /- > T- 'i ]. o o Company s Equity $ 18,800 Store Equipment 8,000 Delivery Equipment 8,000 Merchandise 22,000 Produce 2,500 Accounts Receivable 58,500 Notes Receivable 5,200 Bonds of Other Corporations, Pledged $22,000 Less: Liability Thereon 10,000 "ii 1 - 'VM' . U 01 'Ci ; "!,'!',> Company's Equity 12,000 Cash 79.78o $214,780 1336 CORPORATE ACCOUNTING [Bk. III- Liabilities Mortgage Note on Real Estate $25,000 Deducted Contra 25,000 Notes Payable Secured $10,000 Deducted Contra 10,000 Notes Payable Unsecured . . . $ 15,000 Accounts Payable 91,460 Net Worth 108,320 $214,780 As the capital stock is $150,000 and the net worth but $108,320, the above statement shows a deficit of $41,680. In other words, the stockholders have $108,320 of their capital left. 324. Sale by the Receiver The proposals for reorganization which have been made have not been acceptable to the unsecured creditors or to the stock- holders, and the receiver has been unable to secure a satisfactory offer for the sale of the business as a going concern. On Septem- ber i, 1922, the court therefore orders him to dispose of the stock of merchandise on hand and discontinue the business. This involves the collection of the receivables and the sale of a suffi- cient quantity of the other assets to cover the liabilities and the expenses of receivership. Any remaining assets could then be returned to the stockholders. In this case, however, the stockholders did not desire to con- tinue a losing business with impaired capital, and therefore decided to dissolve the corporation, directing the receiver to dis- tribute the remaining assets direct to the stockholders. The court made its order to the same effect, and in accordance there- with the receiver conducted a special sale to dispose of the mer- chandise and produce, selling the last below cost. He also secured purchasers for the fixed assets- at various prices, and as he collected cash he proceeded to liquidate the liabilities. His Ch. 31] RECEIVERSHIP AND SALE 1337 most difficult task was the collection of the debts due the insol- vent company, and the slowness with which these were realized upon made his task a long one. 325. Loss and Gain on Realization Account In this illustration the profit and the loss on realization is carried to a "Loss and Gain on Realization" account, which is merely an ordinary Profit and Loss account used only for those losses and gains resulting from realization. As each asset is disposed of, the receiver debits Cash with the amount received, credits the asset account with the appraised value, and enters the difference to Loss and Gain on Realization as a debit if it is a loss, or as a credit if it is a gain. It is assumed that the receiver sells the store equipment, valued at $8,000, for $9,000. The entry for this is as follows: Cash , $9,000 To Store Equipment $8,000 Loss and Gain on Realization 1,000 (Full explanation here.) The next entry records the compromising by the receiver of an account receivable of $320, which had been appraised at its face value. A dispute arose regarding the account, and the receiver agreed to accept $275 in full of the claim. The entry is: Cash Itf'Vb'/ 1 .': '-s&lv: . B .V : . . . . $275 Loss and Gain on Realization 45 To Accounts Receivable $320 (Full explanation here.) The receiver is able to sell the real estate for $20,000 cash, the purchaser assuming the mortgage. For this transaction he makes the entry: Cash $20,000 Real Estate Mortgage Note 25,000 To Buildings and Properties $43,800 Loss and Gain on Realization 1,200 Real estate sold for $20,000 cash to John Williams who assumes the mortgage liability. 1338 CORPORATE ACCOUNTING [Bk. III- 326. Liquidation of Liabilities As the receiver has a large amount of cash he will probably be willing to make a partial payment on the liabilities. In doing this he must use care to pay the preferred claims first in the order of their preference. He must also be careful not to pay any creditor a larger percentage of the amount due him than he does another creditor of equal rank. The entries for the payments of "dividends," as they are frequently called, to creditors will ap- pear in the cash book and will be credits to Cash and debits to the liability accounts. In the present instance, when the receiver has paid off all the liabilities, the total of the cash book entries, except for that secured by the mortgage on the real estate, will be equivalent to the following: Nbtes Payable Secured $10,000 Notes Payable Unsecured 15,000 Accounts Payable 91,460 To Cash $116,460 327. Expenses of Realization During the process of winding up the affairs of the company the receiver has had to incur certain expenses for selling, labor, advertising, etc. These may be charged to a Receivership Ex- pense account, to separate expense accounts, or even to the Loss and Gain on Realization account (though preferably not), and the various cash book entries recording them would have in the aggregate the following effect: Receivership Expense $5,000 To Cash $5,000 In this statement of expenses the receiver has included only the nominal salary allowed him as a drawing account by the court upon his appointment. When he makes his report it is probable that he will be allowed additional compensation. The court will also determine the amount of the fee to be allowed the attorneys. Ch. 31] RECEIVERSHIP AND SALE 1339 328. Receiver's Closing Entries At the time of rendering his final report the receiver has turned all the assets into cash and paid all the liabilities and ex- penses of receivership. His trial balance at that time is assumed to be as follows: Debit Credit Cash $110,320 Receivership Expense S.ooo Loss and Gain on Realization $ 7,000 Willis Grocery Company 108,320 $115,320 $115,320 The amount of the credit to the Willis Grocery Company is still the net worth of that company as shown by the statement of affairs of September 30. When the receiver renders his report he will close the Receiv- ership Expense account and the Loss and Gain on Realization account into the Willis Grocery Company account, showing an increase in the stockholders' equity by the amount of his net gain on the realization of the assets over the expense of receiver- ship. The entry will be: Loss and Gain on Realization $7,ooo To Receivership Expense $5,000 Willis Grocery Company 2,000 To close the nominal accounts into the Company's equity account, which is thereby increased by the amount of the receiver's gain over appraised values. The additional allowances made by the court to the receiver and the attorneys total $4,000, and the receiver is ordered to pay them and to pay over the remaining $106,320 to the corporation. The payment of this $4,000 to himself and the attorneys must now be debited directly to the Willis Grocery Company account as the nominal accounts are closed. Any other adjustments made necessary by the act of the court after the receiver's final report was filed would be handled in the same way. The entry in this instance would be: 1340 CORPORATE ACCOUNTING [Bk. III- Willis Grocery Company ............ 3aftta3 . SA'f'&i.O.e'.T^ . $4,000 ToCash ..... '' $4 ' 000 For payment of the balance of the cash to the corporation a similar entry will be made : Willis Grocery Company ............................... $104,320 To Cash ....................................... $104,3 20 There is now no balance in any account and the receiver re- turns the books to the corporation. 329. Dissolution Following Bankruptcy The insolvency or bankruptcy of a corporation does not nec- essarily involve dissolution. Unless formal proceedings are taken to dissolve the corporation, it will survive and may be again used as a business organization. As there is a possibility of the officers and stockholders being involved in penalties and liabili- ties by the continuance of an inactive corporation, it is safer to go through a formal dissolution when the corporation is not to be used again for active business purposes. In the present instance there would perhaps be no real neces- sity for entering on the books of account the transactions having to do with the dissolution, as the entries are merely formal and the transactions will be fully shown by the minutes. It is, how- ever, preferable to make the entries that the record may be com- plete. They will be shown in the following sections. 330. Entry of Assets on Corporation Books after Receivership Since the receiver has permanently closed the books of the company, it is necessary for the corporation to reopen them in order to make any further entries. The assets of the corpora- tion consist solely of the cash turned over by the receiver. There are no liabilities except the capital stock of $150,000. The difference between the amount of cash and the par value of the stock is the deficit of the corporation, and the entry re-establish- ing the accounts would be as follows: Ch. 31] RECEIVERSHIP AND SALE 1341 Cash $104,320 Defidt 45,680 To Capital Stock $150.000 Re-establishing on the books the assets and capital of the Willis Grocery Company prior to distribution and dissolution. 331. Entries for Distribution and Dissolution The stockholders expend $320 in the expenses of dissolution and divide the remainder in proportion to the stockholdings. The ordinary cash book entries will cover the payment of the expenses, Deficit being debited. The distribution will also be handled by a cash book entry, Capital Stock being debited with $150,000, and Deficit credited by a contra entry with the amount needed to close the account, $46,000. The entry will have the following effect: Capital Stock $150,000 To Cash $104,000 Deficit 46,000 For distribution of cash among the stockholders in pro- portion to their holdings; and for closing the capital accounts. All book accounts of the dissolving company are now closed, and the company's charter is surrendered by due process, which varies in the different states. 332. When the Corporation Is Not Dissolved In the above example it was assumed that the stockholders of the corporation wished the receiver to sell all the assets in order that the corporation might be dissolved rather than con- tinue a losing business with impaired capital. If this had not been so, the receiver would only realize on a sufficient amount of the assets to liquidate the liabilities and to pay the expenses of receivership. The remainder of the assets would then be re- turned to the corporation. Such a case is analogous to a receiver- ship followed by reorganization, and the same principles apply. 1342 CORPORATE ACCOUNTING Bk. IIT- 333- Report of the Receiver The remaining sections of this chapter are devoted to the pres- entation of a more complete illustration of the accounting fea- tures of the reports rendered by the receiver to the court. A complete copy of the inventory and appraisal made for the re- ceiver should accompany the statement of affairs, but as this contains nothing of accounting interest it is omitted. The following statement of affairs is more complex and its style more formal than those which have appeared previously. Its form is that which is generally adopted in practice. LONGWORTH STORE COMPANY STATEMENT OF AFFAIRS Ax DATE OF FAILURE, MAY i, 1921 Book Estimated Assets Value to Realize Cash on Hand $ 5.5o $ 5,500 Property 14,000 9,000 Notes Receivable, good 4,250 4,250 Customers: Good 1,000 1,000 Doubtful 600 200 Bad i ,000 Merchandise 24,650 15,000 Securities $28,000 28,000 Pledged with Partially Secured Creditors, per contra. . 3,000 $25,000 Pledged with Fully Secured Creditors for Debts of $I7 ' 000 ........ : ............ ifttrani. ..... 25 ' riw Surplus of Securities, per contra .......................... 8,000 Total . , , , $79,000 $42,950 Deduct: Amounts Due Preferred Creditors, per contra 700 Assets Available for Dividends $42,250 (Equivalent to a dividend of 92.05% on claims of 45,900, exclusive of realization expenses.) Deficiency to Creditors 31650 $45,9 Ch. 31] RECEIVERSHIP AND SALE 1343 Gross Expected Liabilities Amount to Rank Preferred Creditors: Wages, Salaries, Taxes, deducted from assets contra $ 700 r'uliy Secured Creditors: On Book Accounts $17,000 17,000 Estimated Value of Securities 25,000 Surplus, to contra $ 8,000 Partially Secured Creditors: On Book Accounts $23,900 23,900 Estimated Value of Securities 3,ooo $20,900 Unsecured Creditors: On Book Accounts 25,000 25,000 Total $66,600 Liabilities Due to Ranking Creditors $45,900 Capital Stock $25,000 Less: Deficit 1 2,600 Capital 1 2,400 Total $79,000 ===== 334- Statement of Deficiency Another schedule which is usually filed at the same time as is the statement of affairs, is variously known as the statement of deficiency, deficiency statement, or deficiency account. The purpose of this exhibit is to display the items making up the de- ficiency to creditors as shown on the statement of affairs. It shows to what extent the capital has been impaired if there is a nominal net surplus, or how far the company falls short of being solvent if there is an actual deficit. The deficiency statement usually begins with the net worth of the corporation as shown by its books at the time of the last closing, adjusts that net worth for profits made or losses incurred since that time, and for dividends declared, and then further ad- 1344 CORPORATE ACCOUNTING [Bk. III- justs this net worth according to the book values, by showing the effect thereon of the changes in valuation occasioned by the receiver's appraisal. The final figure thus obtained is the de- ficiency to creditors as shown on the statement of affairs. The following statement of deficiency is prepared in what is known as the report form : LONGWORTH STORE COMPANY DEFICIENCY ACCOUNT AT TIME OF FAILURE, MAY i, 1921 (Being an analysis of the deficiency to creditors as shown in the statement of affairs.) Capital Stock $25,000 Surplus, December 31, 1920 1,050 Net Worth by Books, December 31, 1920 $26,050 Interim Dividends Paid to May i, 1921 $6,250 Trade Losses to May i, 1921 7.400 Total Deductions by Book Values 13.650 Net Worth by Books at Date of Failure $12,400 Shrinkage in Book Values of Assets as Shown by Appraisal: Property $5,000 Merchandise 9.650 Customers' Accounts 1,400 Total Shrinkage 16,050 Deficit to Creditors as Shown by Statement of Affairs $ 3,650 From the above statement of affairs and deficiency statement it will be seen that the capital and surplus, amounting to $26,050, have been wiped out, and $3,650 of the assets besides. 335- Deficiency Statement in Account Form The statement of deficiency is sometimes shown in account form, in which case the net worth by the books at the date of Ch. 31] RECEIVERSHIP AND SALE 1345 the last closing and any additions thereto are credits, and losses, dividends, and shrinkage are debits. The balance, if it falls on the credit side, is the deficiency to creditors as shown by the statement of affairs; if it falls on the debit side it is the nominal net surplus as shown by that statement. 336. Receiver's Cash Account The activities of the receiver in realizing upon assets and in liquidating liabilities are set forth in the following Cash account. Several months are usually required for the settlement of an estate in bankruptcy, and during that period two or more divi- dends may be paid to creditors. FIRST AND FINAL ACCOUNT OF ALFRED S. DICKINSON, RECEIVER IN BANKRUPTCY FOR THE ESTATE OF LONGWORTH STORE COMPANY, BANKRUPT MAY i, 1922 THE TRUSTEE CHARGES HIMSELF WITH: Cash Taken Over $ 55o Proceeds of Sale of Property 9,000* Profit on Sale of Property 1,000 Proceeds of Sale of Merchandise 15,000* Profit on Sale of Merchandise 1,000 Amounts Collected from Notes Receivable 4, 250 Amounts Collected from Customers Vjj-Uuo 1,200 Amounts Collected from Customers in Excess of Estimate 50 Proceeds of Sale of Pledged Securities (less claims of Secured Creditors, $20,000, per contra) 28,000 Total Debits $65,000 THE TRUSTEE TAKES CREDIT FOR: Payment of Preferred Claims $ 700 First Dividend to Unsecured Creditors, being 50% on $45,900 22,950 Payment to Fully Secured Creditors from Sale of Pledged Securities, per contra 17,000 * These are the amounts as per statement of affairs. 1346 CORPORATE ACCOUNTING [Bk. Ill- Payment of Partially Secured Creditors, or Portion Secured from Sale of Pledged Securities, per contra 3,000 Expenses of Administration and Commission to Trustee 2,500 -.'it i. lib:/.; Total Credits $46, 150 Final Dividend of 41.07% by Order of Court 18,850 Total Payments $65,000 J! dzs'J a'iav ' ===== ' Summary Total Receipts of Cash $65,000 Total Payments to Secured and Preferred Creditors and for Expenses. . . 23,200 Total Dividends to Creditors, being 91.07% $41,800 RECEIVER'S CASH ACCOUNT Receipts Amount on Hand $ 5,500 Sale of Property 10,000 Sale of Merchandise 16,000 Notes Receivable 4,250 Customers' Accounts 1,250 Sale of Securities 28,000 $65,000 Payments Preferred Claims $ 700 First Dividend 50% 22,950 Secured Claims 17,000 Secured Claims 3,000 Expenses and Commissions. . . 2,500 Dividend, 41.07% Final Settle- ment 18,850 $65,000 Vouchers for all cash disbursements should be ready for the court's inspection personally or through auditors at all times during the receivership. 337. The Realization and Liquidation Statement The realization and liquidation statement, or "account" as it was formerly called, is not an account to be used on the books. Rather, it is an accounting for the assets turned over to the re- ceiver and for liabilities liquidated. This account, or state- ment, can be readily understood by reference to the accompany- ing illustration. Ch. 31] RECEIVERSHIP AND SALE 1347 The realization and liquidation statement may be con- sidered as a statement of the company's account with the receiver, in which the receiver is charged with all the assets of the company turned over to him, and credited with all the liabilities to be liquidated by him. He is in turn credited with the amounts which he realizes from the assets, and debited with the liabilities which he discharges. He is charged with any amount by which he was able to sell the assets for more than their appraised value (gain on realization), and credited with any amount by which the assets failed to yield him their ap- praised value. He is debited with the expenses of conducting the receivership, and credited with the payments he makes on those expenses. The balance, if the credits exceed the debits, is necessarily the actual deficiency to creditors after liquidation, or if the debits exceed the credits, the balance will be the amount dis- tributable among the stockholders. The realization and liquidation statement may therefore be described as a summary of the receiver's transactions in selling the assets and collecting debts due to the bankrupt, and also of the liabilities paid by him. It is used much more frequently in Great Britain than in the United States. Expressed in tabular form, its debits and credits are as follows : REALIZATION AND LIQUIDATION STATEMENT Credit: With liabilities to be liquidated. With proceeds of assets realized. With loss due to liquidation. With supplementary credits, if any. Debit: With assets to be realized. With liabilities liquidated. With expenses of realization and liquidation. With gain on realization credited to Capital account. With supplementary charges, if any. In the following illustration the assets and liabilities are shown separately for greater convenience in illustrating the divi- sions and cancellations: '348 CORPORATE ACCOUNTING [Bk. III- REALIZATION AND LIQUIDATION ACCOUNT OF LONGWORTH STORE COMPANY As OF MAY i, 1922 ACCOUNT OF ASSETS To be Realized: Cash (see Cash Account) Property $ 9,000 Merchandise 15,000 Securities 28,000 Notes Receivable 4.250 Customers' Accounts. . 1,200 Total $57.45 Gain on Realization: Increase in Value of Prop- perty over Appraisement . i ,000 Increase in Value of Mer- chandise over Appraise- ment 1,000 Customers' Increase 50 $59,500 Realized : Property $10,000 Merchandise 16,000 Securities 28,000 ^ Notes Receivable 4,250 Customers' Accounts 1,250 ACCOUNT OF LIABILITIES Liquidated: Preferred Claims $ 700 Secured Creditors 20,000 First Dividend to Creditors . 22,950 Second Dividend to Creditors 18,850 Total $62,500 Commissions and Expenses . . . 2,500 Balance Loss to Creditors, carried to Capital Account. . 4, i oo $69,100 To be Liquidated : Preferred Claims $ -joe Secured Creditors 20,000 Unsecured Creditors 25,000 Partially Secured Creditors . 20,900 Total $66,600 Supplementary Credits: Commission and Expense of Trustee 2,500 $69,100 Part VII Corporation Statements CHAPTER XXXII CLOSING THE BOOKS 338. The Annual Closing At the end of each fiscal year, or oftener, it is customary to "close the books," that is, "close the ledger." Where it can be done conveniently, it is usual and advisable to make the fiscal year correspond with the calendar year; but in many cases it is preferable to have the fiscal year end at a time when business is slack, or when the inventory can be taken with the least labor. In the dry-goods business, for instance, the fiscal year might be made to close just before the fall merchandise comes in, when the stock is low, so that the physical inventory may be taken with comparative ease. At the closing date it is the practice to prepare such state- ments, usually profit and loss statement and balance sheet, as will clearly exhibit the business operations of the company for the year and also show its true financial condition at the end of the year. 339. Monthly Statements Financial statements do not, however, in themselves necessi- tate a closing of the books. In fact, they are usually made up monthly, quarterly, or half-yearly for the purpose of supplying information which the officers and directors need before the time of the annual closing. This does not mean that the ledger is closed, or that changes are made in any of the accounts, but 1349 1350 CORPORATE ACCOUNTING [Bk. III- simply that the required balances, inventory totals, and accrued items' are compiled from the books and records as they stand, and are presented in condensed form to the corporation officials. A complete profit and loss statement can be made each month with but little extra work, if the amount of the inventory is available. In many companies, however, it is the practice to make adjusting entries each month to bring the ledger into harmony with the monthly profit and loss statement and balance sheet. In that case all prepaid and accrued items, as interest, insurance, taxes, must be considered. The distribution of overhead ex- penses is also a feature of great importance in the case of manu- facturing establishments, but as all of these matters are of general accounting interest and not distinctively corporate, they cannot be discussed at length here, 340. Procedure in Closing the Books The steps to be taken in the annual closing of the books are briefly as follows : 1. Take trial balances of all ledgers and see that the totals of the trial balance of each subsidiary ledger are in accord with its controlling account in the general ledger. 2. Determine the inventories of merchandise, properties, supplies, etc., making adjustments where necessary, and enter them in the respective accounts. 3. Compute the prepaid and accrued items and make entries to the proper accounts. 4. Determine depreciation of properties and make the necessary entries. 5. Enter all proper additions to reserves of every nature. 6. Close the nominal accounts into Profit and Loss account. 7. Carry the net profit or loss to Surplus account or to Undivided Profits account. Ch. 3 2] CLOSING THE BOOKS 1351 8. Balance and rule the nominal accounts and bring down the balances where they exist. 9. Make a second or "after closing" trial balance of the ledger, in which the only balances now are those of assets and liabilities. The same procedure is followed when an actual closing of the ledger is made monthly. 341. Closing the Ledger The ledger must be closed systematically with the various nominal or profit and loss accounts properly subdivided. For example, all accounts directly affecting production costs should be closed into the Manufacturing account, in order to determine the exact cost of the finished stock; and all selling expenses, administrative expenses, etc., should be carefully classified and closed in accordance with the degree of information required and the plan of the bookkeeping system. The net profit must of course be clearly stated, and sometimes the gross profit as well. It is not necessary to close the real or asset and liability accounts, except when they are balanced by settlement or adjustments, or when forwarding them to another page or to another ledger. When closing the ledger, transfers of the nominal accounts to the summarizing accounts and to the Profit and Loss account should be made by journal entry instead of directly on the face of the ledger without supporting journal entries or explanation. The journal thus collects all of the items and provides a means of showing what makes up each ledger entry and why. The journal explanation may be very brief, but should be clear and unmistakable for the benefit of others who may have to refer thereto. The methods of closing the accounts peculiar to corporations have already been discussed in connection with the treatment of the accounts themselves. While some of the most difficult problems in accounting arise in connection with closing the 1352 CORPORATE ACCOUNTING [Bk. III- books, yet these are not matters of such exclusive corporate interest that they can be gone into here. 342. Closing the Profit and Loss Account The outstanding difference between corporation book- closings and those of partnerships and individual proprietorships is in the accounting treatment of net profits when their amount has been ascertained. In the case of partnerships and individ- ually owned businesses, just as in the case of the corporation, profits are determined by closing all items of income and expense into the Profit and Loss account. In the books of the pro- prietorship this account is then closed out by an entry which removes its balance to the proprietor's Capital account. In the same way the balance of the Profit and Loss account of a partner- ship is closed out by a journal entry into the capital accounts of the partners, being divided among these accounts according to the profit-sharing ratio of the partners. The net worth of the business is thus reflected directly by the capital accounts, which are increased by profits earned and reduced by losses sustained. In corporations, however, a rigid separation is maintained between the capital stock values which correspond in a general way to the original investment of proprietor or partners- and profits and losses, the balance in the Profit and Loss account being closed into Surplus, Earned Surplus, or Undivided Profits account, depending on the accounting scheme of the corporation. Profits and losses of corporations are thus kept entirely separate from the investment of the stockholders. 343. Entries for Closing into Surplus If a profit has been made during the accounting period, the balance in the Profit and Loss account will of course be on the credit side. The entry closing such a balance will be: Profit and Loss $43, So Surplus $43,000 To close the amount of the year's profit, as shown by the Profit and Loss account, into Surplus. Ch. 32] CLOSING THE BOOKS 1353 If a loss has been sustained the balance will be on the debit side of the Profit and Loss account, and the entry will be : Surplus $13,000 To Profit and Loss $13,000 To charge the amount of the year's loss, as shown by the Profit and Ix>ss account, against Surplus. If the corporation has its surplus classified by the various sources from which it arose, 1 Earned Surplus account would receive the profit or loss. If the account is called "Undivided Profits" instead of "Surplus," the entry would be the same except for the change hi name. As has been said, Surplus account is sometimes called "Surplus and Deficit" to make the title descriptive of both kinds of balances which may appear therein. This is more usually true of corporations which sustain a loss the first year and consequently have a deficit at the time when the account is first needed, than it is of those which have profits at the time of the first closing. If the books are actually closed monthly, the income and expense accounts being charged or credited into Profit and Loss at each trial balance time, it is not the usual practice to transfer the month's profit or loss into Surplus immediately. The plan is favored of allowing the profits and losses of an entire fiscal period to accumulate in the Profit and Loss account, and at the end of that period to close the aggregate net balance into Surplus by whichever of the above entries is applicable. See Ch. IV, "Classification of Surplus." CHAPTER XXXIII FORMS OF STATEMENTS 344. Corporate Reports There are two types of corporate reports and statements: those rendered by the directors and corporate officials to the stockholders and governmental authorities, and those rendered by the accounting department of the corporation to the execu- tives. It is to the latter class that the present discussion will be directed. 345 Necessity for Reports To manage the business intelligently it is essential that cor- porate officials be constantly informed as to the financial status and progress of the concern. In the case of the small corporation where the executives are in intimate touch with the daily activities of the business, monthly or even quarterly statements of income and profit and loss and balance sheets are adequate to give them sufficient information to run the business properly. In the case of the large corporation, however, where the scope of activity and the volume of business is such that it is absolutely impossible for the executive to keep in close personal touch with the various details of the business, it is the duty of the accounting department to provide suitable statements and statistical data to keep him thoroughly informed. In an organization of this type it may be necessary to have daily reports showing in memorandum form the essential facts of the business such as the sales, purchases, collections, expendi- tures, bank balances, manufacturing or operating details; weekly or monthly statements of cash receipts and disburse- ments; monthly statements of income and profit and loss, and 1354 Ch. 33] FORMS OF STATEMENTS 1355 balance sheets, together with such other statistical information as may be needed. . 346. Form of Statements There are no generally accepted or standard forms for cor- porate statements. Indeed it may be truthfully said that no standard form could be designed which would be suitable to all or even a majority of cases. The best education in the preparation of statements is a study of those which are con- sidered fairly representative of the best practice. Modifications will often prove necessary to meet the needs of particular cases, but when making these modifications the accountant must be most careful to see that the statements rendered will not be misleading, and that they convey their information in as interest- ing and clear a manner as possible. The expression "a good statement" has two meanings. It means a statement which shows a sound or good condition, and it also means a statement which is well prepared. Very often the statement which is "good" by the first meaning will not be really effective unless it is "good" by the second meaning also. Facts, or results, can be expressed clearly enough in either statement or graphic form; but unless the statement is neat and attractive it may fail entirely as to result. Why? Because a badly arranged and carelessly executed statement is like a poor window display it fails to catch the eye and engage the direct attention desired. A well conceived and neatly typed statement attracts immediate interest as a stunning window display often stops the passer-by in his tracks. . . . Make them hit home by dressing them up. You can't compel attention unshaven and unshined, no more can written or graphic statements unless they are given the benefit of careful attention to every detail that goes to make up the factor of Psychology attrac- tiveness of form. But the moral need not be lost on those who have to read and study statements. They can insist on the kind that compel attention and achieve results. A lot of the rest represent wasted effort, ink and paper. 1 1 "The Psychology of a Good Statement," by Neill Hutchings, Administration, Feb. 1922, pp. 207-208. 1356 CORPORATE ACCOUNTING [Bk. III- 347. Balance Sheets FEDERAL RESERVE BOARD Assets Cash: la. Cash on hand currency and coin, ib. Cash in bank . . Notes and accounts receivable: 3. Notes receivable of customers on hand (not past due). . . ;vK> 5. Notes receivable discounted or sold with indorsement or guaranty 7. Accounts receivable, customers (not past due) 9. Notes receivable, customers, past due (cash value, *) ii. Accounts receivable, customers, past due (cash value. Less: 13. Provisions for bad debts 1 5 . Provisions for discounts, freights, allow- ances, etc Inventories: 17. Raw material on hand 19. Goods in process 21. Uncompleted contracts Less payments on account thereof 23. Finished goods on hand Other quick assets (describe fully) : Total quick assets (excluding all investments) Securities: 25. Securities readily marketable and salable without im- pairing the business 27. Notes given by officers, stockholders, or employees . . . 39. Accounts due from officers, stockholders, or employees. . Total current assets . Fixed assets: 31. Land used for plant 33. Buildings used for plant 35. Machinery 37. Tools and plant equipment 39. Patterns and drawings 41. Office furniture and fixtures 43. Other fixed assets, if any (describe fully) Less: 45. Reserves for depreciation . Total fixed assets , Deferred charges: 47. Prepaid expenses, interest, insurance, taxes, etc , Other assets (49) Total assets. Ch. 33] FORMS OF STATEMENTS 1357 FORM OF BALANCE SHEET Liabilities Bills, notes, and accounts payable: Unsecured bills and notes 2. Acceptances made for merchandise or raw material purchased 4. Notes given for merchandise or raw material pur- chased 6. Notes given to banks for money borrowed 8. Notes sold through brokers 10. Notes given for machinery, additions to plant, etc. 12. Notes due to stockholders, officers, or employees Unsecured accounts 14. Accounts payable for purchase (not yet due) 16. Accounts payable for purchases (past due) 18. Accounts payable to stockholders, officers, or em- ployees Secured liabilities 2oa. Notes receivable discounted or sold with indorse- ment or guaranty (contra) sob. Customers' accounts discounted or assigned (contra) zoc. Obligations secured by liens on inventories 2od. Obligations secured by securities deposited as collateral 22. Accrued liabilities (interest, taxes, wages, etc.). Other current liabilities (describe fully): Total current liabilities , Fixed liabilities: 24. Mortgage on plant (due date ) 26. Mortgage on other real estate (due date ) . . . . 28. Chattel mortgage on machinery or equipment (due date ) 30. Bonded debt (due date ) 32. Other fixed liabilities (describe fully): Total liabilities , Net worth: 34. If a corporation Preferred stock (less stock in treasury) , ury) , b) Common stock (less stock in treas c) Surplus and undivided profits Less: (d) Book value of good-will . (e) Deficit 36. If an individual or partnership (a) Capital (6) Undistributed profits or deficit. Total... CORPORATE ACCOUNTING [Bk. III- FORM C. C. CHILDS ST. Louis, BALANCE DECEMBER Assets CASH: Cash in Offices $ 12,750.00 Cash in Banks 94,675.91 Total Cash $ 107,425.91 NOTES AND ACCOUNTS RECEIVABLE: Accounts Receivable, Customers', Not Due $ 637,982.26 Accounts Receivable, Customers', Past Due 51,447-35 Railroad and Insurance Claims 11,170.17 Total Outside Receivables $ 700,599.78 Less: Allowance for Doubtful Receivables 44,728.12 Total Outside Receivables, Good 655,871.66 INVENTORIES: Raw Material $ 573,742.32 Goods in Process 187,707.84 Finished Goods . : : v.v.V. .V. ...'... 1,432,772.13 Total Merchandise Inventories 2,194,222.29 U. S. LIBERTY LOAN BONDS 160,400.00 TOTAL QUICK ASSETS .".' ' '$3,117,919.86 OFFICERS AND EMPLOYEES' ACCOUNTS AND STOCK SUBSCRIPTIONS .'.' '.'. 114,740.24 TOTAL CURRENT ASSETS '.'.'.' $3,232,660.10 FIXED ASSETS: Land '. $ 249,592.67 Buildings $ 580,910.21 Less: Allowance for Depreciation 156,209.38 Buildings, Net Value . .'.' 424,700.83 Office Furniture and Fixtures $ 19,085.04 Less: Allowance for Depreciation 9,782.15 Office Furniture and Fixtures, Net Value 9,302.89 Factory Fixtures $ 197,627.76 Less: Allowance for Depreciation 102,622.07 Factory Fixtures, Net Value 95,005.69 Machinery and Tools $1,583,754.68 Less: Allowance for Depreciation . '. 538,632.60 Machinery and Tools, Net Value . 1,045,122.08 Automobiles and Trucks $ 55,182.79 Less: Allowance for Depreciation 20,464.21 Automobiles and Trucks, Net Value 34,718.58 TOTAL FIXED ASSETS 1,858,442.74 DEFERRED CHARGES: Supplies Inventory , $ 47,337.92 Prepaid Insurance 21,904.95 Prepaid Royalties 5,000.00 Total Deferred Charges 74,242.87 TOTAL ASSETS $5,i6s.34S-7i Ch. 33] FORMS OF STATEMENTS 1359 B AND COMPANY MISSOURI SHEET 31, 1921 Liabilities and Capital CURRENT LIABILITIES (UNSECURED): Notes to Banks $ 180,000.00 Accounts Payable, Trade 178,046.58 Accounts Payable, Sundry 160,689.44 Total Current Liabilities (Unsecured) $ 518,736.02 FIXED LIABILITIES: First Mortgage Bonds Outstanding, due 1935 $ 800,000.00 Less: Sinking Funds in Hands of Trustee: Cash $ 2,436.07 Investments 349,600.00 Total Sinking Funds 352,036.07 Net Fixed Liabilities 447,963.93 ACCRUED LIABILITIES: Interest, Taxes, etc. (including Federal Income Tax) 514. 495-65 TOTAL LIABILITIES $1,481,195.60 NET WORTH: Preferred Stock, Authorized $5,000,000.00 Less: Unissued $3,000,000 In Treasury 1,000,000 4,000,000.00 Outstanding $1,000,000.00 Plus: Subscribed 100,000.00 Total Preferred Capital Stock $1,100,000.00 Common Stock of No Par Value, 50,000 shares authorized, 20,000 shares outstanding 800,000.00 Total Capital Stock $1,900,000.00 Earned Surplus (available for dividends). . $1,432,150.11 Reserve for Sinking Fund 352,000.00 Total Surplus 1,784,150.11 NET WORTH 3,684,150.11 TOTAL LIABILITIES AND CAPITAL $5.165,345.71 1360 CORPORATE ACCOUNTING [Bk. III- The balance sheet is usually considered the most important financial statement. While there is and can be no standard form of balance sheet, yet many accountants are endeavoring, so far as is practicable, to standardize on that shown in Form A (see pages 1356-57). This form was first suggested in the Federal Reserve Bulletin as "a tentative proposal submitted by the Federal Reserve Board" for the consideration of bankers, merchants, manu- facturers, and accountants. In designing the form and in drawing up the excellent suggestions for the preparation of bal- ance sheet statements which accompany it, 2 the Board had the co-operation of some of the leading accountants of the country, and it is therefore probable that this form more nearly meets general authoritative approval than any other. Form B shows a corporate balance sheet prepared along the lines of these in- structions. 348. Capital Stock on the Balance Sheet The instructions for the preparation of the approved Federal Reserve form of balance sheet, which accompany the form, provide that "on the balance sheet each class, if more than one, of stock must be stated, giving the amount authorized, issued, and in treasury, if any." This is the usual practice, as follows: Capital Stock: Common Authorized $10,000,000 Less: Unissued -. 5,000,000 Common Stock Outstanding $5,000,000 Preferred Authorized $10,000,000 Less: Unissued $5,000,000 In Treasury 2,000,000 7,000,000 Preferred Stock Outstanding 3,000,000 Total Capital Stock $8,000,000 * Approved Methods for the Preparation of Balance Sheet Statements, Washington, Gov- ernment Printing Office, 1918. Ch. 33] FORMS OF STATEMENTS 1361 349. Subscriptions to Capital Stock on the Balance Sheet The amounts receivable on subscriptions to capital stock are an asset and should be shown on the asset side of the balance sheet, with possibly the setting up of a deduction similar to an allowance for bad debts in case the payments are not being made as due, or look doubtful for other reasons. Such an asset as this would be placed under item 29 on the Federal Reserve form. The amount of capital stock which is reserved to be issued to the subscribers upon payment in full of their subscriptions, should be shown under the capital stock grouping on the balance sheet. Assuming $100,000 of preferred stock so reserved, the preferred stock referred to in the preceding section would appear as follows: Preferred Authorized $10,000,000 Less: Unissued $5,000,000 In Treasury 2,000,000 7,000,000 Preferred Stock Outstanding $ 3,000,000 Plus: Subscribed 100,000 Preferred Capital Stock $3,100,000 350. No-Par Stock on the Balance Sheet Stock of no par value is carried on the balance sheet at the value at which it appears in the Capital Stock account. The balance sheet should also show (either in the body thereof or as a footnote thereto) the number of shares outstanding, thus enabling the book value of each unit of interest to be readily found. If the common stock in the foregoing illustration were of no par value, it would be shown on the balance sheet as follows : Capital Stock: Common, of no par value, 50,000 shares outstanding $5,000,000 Another method would be as follows : 1362 CORPORATE ACCOUNTING [Bk. Ill- Capital Stock: Common, of no par value * $5,000,000 * 50,000 shares outstanding. 351. No-Par Stock of a Stated Value When no-par stock is carried at a stated value, that value is used in the balance sheet, and any difference between the stated value and the amount for which the stock was actually sold is treated as discussed in a preceding chapter. 3 Form C shows the balance sheet as at December 31, 1920, of the Fierce-Arrow Motor Car Company, which was reincorporated on October i, 1916, with 100,000 shares of 8% cumulative pre- ferred stock, value $100 each, and 250,000 shares of common stock without par value. The preferred stock is preferred as to assets as well as to dividends, is redeemable in whole or in part at 125 and accrued dividends, and is convertible at the option of the holder into common stock, share for share. The two kinds of stock have equal voting privileges. By reference to the balance sheet it will be seen that the company's common stock had a stated value of $5 per share and a book value of $39.49 per share, including capital surplus and earned surplus, so that the conversion privilege does not seem very attractive to the holders of the preferred. This company states its common stock at $5 per share (the minimum required under New York statutes) in addition to which it has a capital surplus of $4,081,411.90, which must be considered as part of the capital, but the report does not show how much, if any, of it belongs to the preferred. The earned surplus of the company stood at $4,541,546.58 on December 31, 1920. This of course must be added to the capital values in arriving at the net worth of the company. The true book values of the common and preferred shares can be determined only after learning the status of the preferred stock as to accumulated earnings. Ch. XI, "Capital Stock Without Par Value." Ch. 33] FORMS OF STATEMENTS 1363 s & Is . < o 1364 CORPORATE ACCOUNTING [Bk. III- It will be seen that this company lists its capital surplus and its earned surplus separately, a plan which should always be followed by corporations carrying unvalued shares of stock at a stated value. This shows the value of assets turned over to the company in excess of the stated value per share of common stock, while the earned surplus represents undivided profits. 352. Surplus on the Balance Sheet The showing of surplus on the balance sheet presents a number of interesting features. In the first place it must be remembered that the Surplus and Capital Stock accounts together make up the net worth of the corporation. The most popular form of balance sheet is one which groups these net worth items in such a way as to show a total of the net worth items. To accomplish this result the capital stock and surplus amounts must be added together to form a total which, added to the total of the liabilities, will give the grand total of the credit side, "Liabilities and Capital." This is illustrated on the balance sheets shown on pages 1358-59. Conversely, if there is a deficit, it will be subtracted from the amount of capital stock to show the net worth, as shown in item 34 of the Federal Reserve balance sheet. There is another theory which is used in the preparation of balance sheets. On the Federal Reserve balance sheet the assets are arranged as nearly as practicable in the order of their availability, and the liabilities in the order in which they are payable, with the net worth accounts last. Under the other plan, exemplified in the balance sheet shown in Form D, the permanent or fixed assets are shown first, and opposite them the sources of capital (usually capital stock and funded debt); the order of the other assets and liabilities being very much as in the first arrangement, with the surplus as the last item on the credit side*. Ch. 33] FORMS OF STATEMENTS 1365 While this method is well established in practice, especially for the balance sheets of utility corporations, it would seem that its disadvantages outweigh its advantages. It is argued that it is more logical to present first the capital assets, with which the business is carried on, in juxtaposition to the sources of capital, but the method fails in entirely accomplishing this because the surplus, which is shown last, is usually tied up also in the capital assets. It has the added disadvantage of not showing readily the net worth of the corporation. While the second method may have some advantages, ... it is perhaps safe to assert that in the majority of cases the former is preferable. It is almost always used in the case of finan- cial institutions. If the balance sheet is primarily intended to be submitted to a prospective lender, prominence should be given to the comparison of current assets with current liabilities by placing them at the top. If the balance sheet is intended for a prospective purchaser, the net worth of the business may well be stated in one amount, thereby conforming to the first arrangement. In the opinion of many accountants, the growing practice of issuing capital stock without par value furnishes an additional reason for showing in the balance sheet the total of the capital stock and surplus. 4 . . . There is an increasing tendency on the part of accountants to make a marked differentiation in the display of liabilities as dis- tinct from proprietorship interest. The old-fashioned balance- sheet in which all credit amounts were tabulated one after the other upon the right hand side without marked grouping or classification has given way to the modern balance-sheet wherein the attempt is made to display definitely all those totals of classification which are of interest to the business world. Liabilities are subdivided so as to show the total of those of a current nature as distinct from those which are of a more permanent nature. The inclusion of capital stock obligations with the permanent liabilities is giving place to the method wherein all proprietorship measurements are grouped together, cumulating in a total which displays in one amount the net excess of all assets over liabilities.' 4 Accountants' Reports, by W. H. Bell, p. 33. 6 "Classification of Surplus," by C. B. Couchman, Journal of Accountancy, Oct. 1921, pp. 368, 269. 1366 CORPORATE ACCOUNTING [Bk. III- FORM THE BLANK BALANCE SHEET, Assets PROPERTY, LESS DEPRECIATION Schedule i $ 462,834.47 GOOD-WILL, PATENTS, AND TRADE-MARKS 250,000.00 INVESTMENT IN SUBSIDIARY COMPANY: * Capital Stock 1,000 Shares of $100 each $136,237.73 Advances 50,000.00 Total Investment in Subsidiary Company 186,237.73 SINKING FUND FOR REDEMPTION OF BONDS CASH AND ACCRUED INTEREST (Bonds Deducted from Liability, per contra) 4,962.94 CURRENT ASSETS: Cash Current Funds $ 97,526.06 Cash on Deposit to Pay Interest and Dividends. . 12,324.97 Salesmen's Working Funds 3,422.95 Trade Notes and Acceptances Receivable 143,212.57 Accounts Receivable: Trade Debtors $261,404.06 Less: Reserves: Discounts $13,386.31 Doubtful Accounts .. 10,326.42 23,712.73 237,691.33 Accounts Receivable Officers and Employees. . . 34,778.67 Marketable Securities Schedule 2 556,183.00 Accrued Interest Receivable 7,981.07 Inventories: Finished Goods $205,042.36 Work in Process 102,193.14 Materials and Supplies 180,269.80 487,505.30 Advances on Materials Purchased 24,967.04 Total Current Assets 1,605,592.96 DEFERRED CHARGES: Unamortized Discount on Bonds $ 24,516.29 Prepaid Insurance, Interest, and Taxes 8,235.24 Experimental Expenses 16,294.08 Total Deferred Charges 49,045.61 TOTAL $2,558,673.71 * Should be named. e By permission from Accountants' Reports, b?' W. H. Bell, p. 97. Ch. 33] FORMS OF STATEMENTS 1367 Liabilities PREFERRED CAPITAL STOCK, 8% Cumulative Authorized, 3,000 shares of $100 each; Outstanding, 2,500 shares $ 250,000.00 COMMON CAPITAL STOCK Authorized and Outstanding, 10,000 shares of $100 each 1,000,000.00 FIRST MORTGAGE 6% BONDS, Due 1934: Issued $500,000.00 Less: In Sinking Fund $ 50,000.00 In Treasury Pledged to Secure Notes Payable 175,000.00 225,000.0 Outstanding 275,000.00 CURRENT LIABILITIES: Notes Payable Loans $100,000.00 Trade Acceptances Payable 190,776.64 Accounts Payable 248,729.57 Interest and Dividends Payable 12,324.97 Accrued Accounts: Income and Excess Profits Taxes (estimated) . . 40,000.00 Wages 13,069.17 Interest 3,762.43 Total Current Liabilities 608,662.78 DEFERRED CREDIT FIRE INSURANCE SUSPENSE 5,491.64 RESERVES: Injuries and Damages $ 8,250.27 Contingencies 25,000.00 Total Reserves 331250.27 SURPLUS FROM REVALUATION OF GOOD-WILL, PATENTS, AND TRADE-MARKS 200,000.00 PROFIT AND Loss SURPLUS: Balance, January i, 1919 $ 85,743.68 Surplus for the year 220,525.34 Total $306,269.02 Less: Dividends 1 20,000.00 Balance, December 31, 1919 186,269.02 TOTAL $2,558,673.71 NOTE: The Company has contingent liabilities of $109,326.73 on account of notes and acceptances receivable discounted. 1368 CORPORATE ACCOUNTING [Bk. III- 353' Reserves on the Balance Sheet We have seen 7 that reserves are of two kinds operating and non-operating reserves and always show credit balances. Of these the operating reserves are not limited in use to corporate accounting, and cannot be discussed here except to say that they should be shown on the balance sheet as deductions from asset values, as in the case of reserves for depreciation and reserves for bad debts; or else shown as accrued liabilities, as in the case of reserves for taxes. It may be repeated that there is a growing objection to giving the name "reserves" to these operating reserves, on account of the confusion that has resulted therefrom. Those which are deductions from asset values are better styled "allowances," as "Allowance for Depreciation" and "Allowance for Bad Debts," and those which represent true liabilities are preferably spoken of simply as accruals, as "Accrued Taxes." In regard to the non-operating reserves, one need remember only that they are nothing more than appropriations of surplus, in order to see that they belong to the net worth group. They represent surplus which has been set aside for some specific purposes and is therefore not available for dividends. The balance sheet on pages 1358-59 shows such an appropriation of surplus. It is also desirable that in the balance-sheet the accountant should display surplus in such manner that the amount available for dividends may be readily ascertainable. All surplus which has been paid in or earned or has resulted from the sale of capital assets is presumably available for distribution as dividends unless it has been definitely appropriated for some other purposes. That which is not available would include any balance of surplus resulting from appreciation of assets and all items of surplus which had been im- pounded by action of the board of directors. 8 , The balance sheet on pages 1366-67 shows a surplus from ap- 7 5 14- "Classification of Surplus," by C. B. Couchman, Journal of Accountancy, Oct. 1921, p. 269. Ch. 33] FORMS OF STATEMENTS 1369 preciation in such a way as to indicate clearly that it is not available for dividends. 354. Analysis of Surplus It is also desirable that the balance sheet shall show the changes in surplus during the last fiscal period, so that a person having the balance sheets as of both the beginning and the end of the year and seeing the difference between the amounts of surplus at those two dates may be able to determine the reasons for the change. Such an analysis would make the surplus section of the balance sheet show in the following form : Surplus, January i, 1921 $50,247.23 Less: Dividend declared March i, 1921 20,000.00 $30,247.23 Plus: Profit of year 1921 12,962.38 Surplus, December 31, 1921 '. $43,209.61 If this analysis of surplus were, however, of any greater length than this, it would be better to make a separate schedule of it in some such form as that which follows : ANALYSIS OF SURPLUS Balance of Surplus, December 31, 1921 $100,000 Adjustments applicable to prior periods: Addition: Refund of Income Tax Overpaid $ 1,000 Deductions: Accounts Payable Not Entered $200 Items Wrongly Capitalized 400 Total Deductions. . 600 Net Increase 400 True Surplus, December 31, 1921 $100,400 Extraordinary Profits this period $17,000 Net Operating Profit this period 43,000 60,000 Amount available for appropriation $160,400 1370 CORPORATE ACCOUNTING [Bk. Ill- Appropriations of Surplus: Reserve for Sinking Fund $10,000 Dividends 20,000 Total Appropriations 30,000 Surplus, June 30, 1922 $130,400 355. Bonded Liabilities on the Balance Sheet Bonds outstanding, of course, appear among the liabilities on the balance sheet. Unsold bonds should not appear as an asset, but should be deducted from the amount authorized. In order that the sold and unsold bonds may be clearly dis- tinguished, they should appear in the balance sheet about as follows: First Mortgage 5% Gold Bonds: Total Amount Authorized : $1,000,000 Less: Unsold Bonds 500,000 Bonds Issued and Outstanding $ 500,000 Bonds repurchased by the company and held alive in the treasury should be clearly indicated in the balance sheet, either as a subdivision of "Investments," or as "Treasury Bonds,'" with a suitable explanation of what is meant thereby, or under such other caption as will clearly indicate the nature of the asset without possibility of misunderstanding. Bonds of the company purchased by the trustees of the sinking fund, insurance fund, reserve fund, beneficial fund, or by any subsidiary or affiliated organization, board, or society, should, however, be listed in the assets of such funds, and not necessarily as treasury bonds. While bonds so purchased are sometimes hidden among the general investments of the company, this should not be done. 356. The Sinking Fund on the Balance Sheet The sinking fund, consisting as it does of cash and securities, would naturally be placed among the assets in the balance Ch. 33] FORMS OF STATEMENTS 1371 sheet; but since the sinking fund assets are not free for use as working capital but have been handed over to the trustee practically as part payment on the bonded debt, there is some question as to the expediency of including them among the balance sheet assets. Many companies list sinking fund assets among the corporate assets, while others show them as deductions from the bonded debt. The plan adopted depends largely on the ideas of the accounting officer or of the corporation officials. The following methods of listing are in common use : i. Sinking Fund in Hands of Trustee $157,130 2 Trustee of Sinking Fund, being amount of cash and securities held by the Trustee for redemption of $1,000,000 5% First Mortgage Bonds of 1936 157,130 3 Sinking Fund Assets, being amount in hands of Trustee, as follows: Invested in Securities $100,000 Cash in Savings Bank 57,130 157,130 4. Sinking Fund Assets. (Cash and securities amounting to $157,130 in hands of Trustee, deducted from outstanding bonds, per contra.) Under the last plan (4) the sinking fund assets appear only as a memorandum among the assets, while the amount of the funds is deducted from the bonds themselves on the opposite side. 357- Good- Will on the Federal Reserve Balance Sheet Attention must be called to the rather unusual manner in which good-will is shown on the approved Federal Reserve balance sheet. All intangible items such as this are ordinarily shown at the bottom of the asset side. It is true that the banker, in examining the balance sheet as a basis for loans, appraises the various assets in his own mind; and that the loan value which he places on good-will is nothing. The banker's viewpoint is emphasized in the handling of this item on the Federal Reserve balance sheet, for it is entirely omitted from the assets. Since with this omission the debits and credits of the statement would not balance, the book value of the good-will is inserted on the liability side as a deduction 1372 CORPORATE ACCOUNTING [Bk. III- from the net worth before that is added to the liabilities. The two sides will thus balance in that the book value of the good- will is deducted from both, being omitted on the debit side, where it would normally be found, and being subtracted from the total of the credits. 358. Other Statements Other statements will necessarily be prepared. These may include a profit and loss statement, schedules of accounts re- ceivable and accounts payable, and any other accounting and statistical data which may be desired. Their preparation, however, involves nothing of purely corporate interest, as they will be in practically the same form for corporations as for partnerships and individual proprietorships. CHAPTER XXXIV CONSOLIDATED STATEMENTS 359- Purposes of Consolidated Balance Sheet A consolidated balance sheet is one that combines the balance sheets of several different concerns. The plan of including in one statement the items of a main company and its various subsidiaries is now in general use, having grown up with the h61ding company. The first important consolidated balance sheet published was probably that issued by the United States Steel Corporation in 1902. This company's consolidated statements still constitute excellent examples, combining as they do the statements of a considerable number of subsidiary companies. The holding company and each of its subsidiaries will have its own statement, but it is frequently necessary or desirable to present all the financial details in one balance sheet, in order to reflect the financial position of the whole group of affiliated companies as one undertaking. The assets and liabilities of the constituent companies are therefore included with those of the controlling company, after eliminating therefrom the inter- company stocks, bonds, and accounts which indicate the relation of one company to another. 360. Need of Consolidated Statements The income of a holding company consists, besides whatever profits may result from its own operations if it is also an operating company, of dividends paid by the companies whose stock it owns. The earnings of these companies may be far greater or less than the amount of dividends paid; in the latter case a surplus will be accumulated by the subsidiaries; in the former 1373 1374 CORPORATE ACCOUNTING [Bk. III- case their respective capitals may be impaired. Under such conditions the cost of the stock of the subsidiaries, as shown on the books of the holding company, will give no idea as to the real worth of the subsidiaries and consequently of the holding company. It should be readily apparent that the cost of stocks owned by a holding company, so often purchased (for book purposes) at figures which may represent anything but their real cash value at the time of purchase, will constitute an entirely inadequate statement of the assets of the holding company. The audit of the books of a holding company, therefore, neces- sarily involves the audit of the books of the subsidiary, so that a comparison may be made between the cost of the stock as shown on the books and the balance sheet of the holding com- pany, with the net worth of the subsidiaries as shown by their balance sheets. The simplest form of presenting the results of this comparison is by a consolidated balance sheet. As an example of the erroneous figures which might result from a failure to examine the books of the subsidiaries in order to show the true value of their stock in the hands of the holding company, Ernest Reckitt, Certified Public Accountant, relates the following experience : I have in mind a case where I was called in to make, as I sup- posed, an audit of the books not only of the "Holding Company," but also of the subsidiary companies, and was amazed to find that it was proposed to have me audit only the "Holding Company's" books. Upon explaining that I could give no certificate on such audit, the most specious arguments were advanced and the pres- ident of the company attempted to use the full force of his strong personality to persuade me to defer to his wishes, which naturally only made me suspect still more the motives which actuated him. Finally, and with great reluctance, they handed me the books of the subsidiary companies, and I found out that two of the com- panies had made losses aggregating over $200,000, no part of which losses had been taken care of on the books of the "Holding Com- pany," though they had been careful to bring on to the books of the "Holding Company" the profits made by other subsidiary com- Ch. 34] CONSOLIDATED STATEMENTS 1375 panics. One year later, the "Holding Company" and most of the subsidiary companies were in bankruptcy, as they deserved to be. 1 361. Effect of Statement Consolidation on Inventories Perhaps the most obvious example of the need of consolidated statements is found in the case of companies one of which sells its products to the other. Assume the case of a candy factory owning a subsidiary which manufactures paper boxes, selling 90% of its output to the parent company. If just before the time for making a statement the subsidiary "sells" its entire finished goods inventory to the candy factory at its usual margin of profit or at an unusual price, the transaction will be represented on the books of the one company by an account receivable, and on the books of the other by an equal account payable. As will be seen later, these will both be eliminated in the consolidated balance sheet. But these same goods will appear on the inventory of the candy factory at a greater book cost than the real cost to the combined interests, because the profit charged by the subsidiary has been included in the inventory. This profit must be eliminated if we are to get down to accepted principles in the valuation of inventories, and in these days of income taxes only a corporation which is very careless or is in desperate straits financially will be willing to pay a tax on such an un- realized profit. 362. Contents of Consolidated Balance Sheet The contents of a consolidated balance sheet are practically the same as of that of a single company. There are, however, certain points peculiar to such statements which require special attention. They are as follows: i. Intercompany obligations existing debts among the constitutent companies for goods sold, for advances made to one another, and for bond interest accrued, or declared 1 Quoted in Auditing Theory and Practice, by R. H. Montgomery (2d Ed.). 1376 CORPORATE ACCOUNTING [Bk. III- dividends being offsetting assets and liabilities, should be eliminated from the combined statement. 2. The excess above cost to the combined interests of any valuation of inventories based on prices at which merchandise is sold by one company to another is eliminated. 3. Intercompany holdings of capital stock are eliminated. 4. Guaranties, leases, and other contracts existing between the parent company and subsidiaries, are shown in the balance sheet among the assets and liabilities or as footnotes. 5. The extent of ownership in the subsidiary companies' stock whether the parent company owns all, a controlling interest, or only a portion thereof and the extent of ownership by the underlying companies in the stock of the parent company or of the other companies, should be clearly stated, either in the balance sheet or in a supporting schedule. The minority interest in surplus profits should also be indicated. 6. The parent company's ownership of bonds of the sub- sidiary companies, and vice versa, should be shown. The effect of these steps will be to furnish a statement which will show the financial standing of the group as an entity, and at the same time the relation of the members of the group to each other. 363. Preparation of Consolidated Balance Sheets The preparation of a consolidated balance sheet requires first the preparation of a fully satisfactory balance sheet of each company. All corrections and other adjustments of the individ- ual statements should be made before work is begun on the consolidation, and the classification of similar items and the terminology used should be the same on all the statements. It will be found that the easiest method of combining the several balance sheets is by entering the various items of each on analysis paper. The names of the companies may be entered in the left-hand margin if they are extremely numerous, the Ch. 34] CONSOLIDATED STATEMENTS 1377 money columns being headed up for the various asset and liability items; but generally the reverse method will be more satisfactory, i.e., entering the names of the companies at the heads of the money columns (using one column for each com- pany), and assigning one line to each of the asset and liability items. The next column (or line) after the enumeration of assets and also after the liabilities, should then be headed "Total," and the totals of each account for all companies should be carried over and balanced, the grand total of assets equaling the grand total of liabilities. Two columns (or lines) may then be provided for adjustments. As these are, however, usually in the nature of eliminations (credits to assets and debits to liabilities) rather than increases, some accountants provide just one column for "Eliminations," entering in red ink any adjustments which are in the nature of increases. 364. Elimination of Intercompany Items Before commencing to eliminate intercompany accounts, these should be reconciled between the various sets of books to make certain that the same amount is shown as a receivable on the part of one company as is shown as a payable on the part of another. Differences may exist in the current account between two of the companies because merchandise shipped and charged by one company has not yet been received and entered by another, dr for other reasons. In the case just mentioned the adjusting entry on the work sheet would debit the Inventory of the receiving company and credit its Intercompany Accounts Payable, as the merchandise should of course be included in the inventory of the group. When all such differences have been adjusted the inter- company accounts receivable will equal the intercompany accounts payable, and all should be eliminated by the proper entries on the work sheet. These items to be eliminated will 1378 CORPORATE ACCOUNTING [Bk. III- include, in addition to debts payable by the holding company or one of the subsidiaries, to another of the subsidiaries or to the holding company for merchandise sold or services rendered, advances of money from one to another, or deposits of money by one of the companies with another, bonds of one of the com- panies held by another, accrued items, and declared dividends. The consolidated balance sheet will therefore show no receiv- ables or payables except those due from and to outsiders. 365. Example of Work Sheet The manner of assembling and combining the items of several component companies into a consolidated balance sheet is shown, in the following example. Three companies, X, Y, and Z, are used in the illustration, the first being purely a holding company, and the other two, subsidiary operating com- panies. Intercompany stockholdings and current obligations that require careful handling are included. Form A, on the following page, shows how the accountant or corporation official gathers details and makes deductions on his "working papers," "working sheets," or "analysis sheets," preparatory to his final exhibit. The assets and liabilities are shown separately and .combined. The eliminations of inter- company items in arriving at the net results are also shown. In the preparation of consolidated balance sheets, the state- ments of the several companies are prepared separately and then brought together, as shown in this form. Of the adjustments shown, those already referred to are the elimination of $15,000 owing by Company Y to Company Z, and of $12,000 owing by Company Z to Company Y (both of which are deducted from "Cash and Sundry Assets" on the asset side) ; the removal of $60,000 of advances by Company X to the other two companies; and the elimination of the $30,000 of bonds of Company Y 7 held by Company X. Ch. 34] CONSOLIDATED STATEMENTS 1379 w g| , 3 S < | H ^ 2 -^ X ^\ 5 Q C H- J2 8 o * w s& - rj ^ <" *3 U X : ^ >, loo ^ c 3 2 ^t* Ai 3 o II "c c 1 4) o O w 5 *- /. "B. S o o 43 C/3 (N O W t>> Tf M IO MM Jfo^NXV u ft u x >, x x .8 888 O 00 O O 1-1 1O CO M CO IN M ^ 10 10 o silii o ^}.2s GO s e g a *-* +J 4J +J 1380 CORPORATE ACCOUNTING [Bk. III- 366. Intercompany Holdings of Capital Stock The other eliminations shown are those of intercompany holdings of capital stocks. In the present simple case these are all carried on the books of the holding companies at par, but frequently this will be found not to be the case. This condition results from the purchase of the stock at a figure other than par, and necessarily means that the holding company has paid a premium for its share of the accumulated surplus of the subsidiary or for the good-will not on the books, or has perhaps received the stock at a discount on account of the existence of a deficit or the lack of that earning power which constitutes the value of good-will. Let us suppose that the par value of a subsidiary's stock is $100,000, all of which has been purchased by the holding com- pany for $i 75,000. This purchase price bought, as has been said, the surplus of the subsidiary including the value of any good-will not on the books. If the surplus by the book values of assets other than good-will at the time of the acquisition of the stock was $25,000, the sum of $50,000 must have been paid for the good-will. The following adjustment will therefore be necessary : Capital Stock of Subsidiary $100,000.00 Surplus 25,000.00 Good-Will 50,000.00 To Investment in Stock of Subsidiary $175,000.00 The rule is admirably expressed as follows : Where the book value of the subsidiary company in a balance- sheet of the company holding that stock is in excess of the par value of the stock plus the surplus of the subsidiary company at the date of acquisition the excess should be charged to goodwill. Where the book value of the stock of a subsidiary company in a balance- sheet of the company holding that stock is less than the capital stock plus the surplus of the subsidiary company at date of acquisi- tion, the difference should be credited to capital surplus, unless there is goodwill of a greater amount either on the accounts of the holding company or of the subsidiary company, or if there is good- will of a greater amount arising from purchases of stocks of other Ch. 34] CONSOLIDATED STATEMENTS 1381 subsidiary companies. This treatment is based on the assumption that goodwill is shown separately, but many companies in their published accounts do not show goodwill separately and simply have an account called "cost of properties." In this case the debits and credits would be made to this account instead of to goodwill or capital surplus. 2 367. Reason for Adjustment of Surplus The reason for eliminating in the consolidated balance sheet the surplus of the subsidiary at the date of the acquisition of its stock by the holding company, instead of including it as a part of the consolidated surplus, is that the surplus of the subsidiary at that time is of the same nature as its capital stock. What the purchaser buys is all or a proportionate part of the net worth or capital, which is arbitrarily divided on the books between the two accounts, Capital Stock and Surplus. A business cannot accumulate a surplus before its inception, neither can it purchase a surplus except through the purchase of the capital stock, but in purchasing all of the capital stock it necessarily purchases all of the surplus. For this reason divi- dends received by the holding company out of surplus accumu- lated by the subsidiary prior to the date of the purchase of its stock, should be credited to the cost of the investment on the books of the holding company rather than to income, since the undivided surplus constitutes part of what the holding company paid for, and the receipt of the dividends is a return of capital invested rather than a profit earned. The Profit and Loss account of a holding company should therefore reflect only the profits earned by the holding company after its organization plus the profits of subsidiaries after the acquisition of their stock by the holding company. 368. Adjustment of Inventories If any one of a group of companies for which a consolidated balance sheet is being prepared has in its inventory merchandise * "Consolidated Accounts," by G. R. Webster, Journal of Accountancy, Oct. 1919, p. 263. 1382 CORPORATE ACCOUNTING [Bk. III- which it has purchased from another company of the same group, the profit made by the vendor company in the sale of the mer- chandise must be eliminated from the inventory valuation, and the merchandise carried in the consolidated balance sheet at its cost to the group. Careful investigation is sometimes required to determine the amount of this profit, which will be eliminated by an adjustment debiting Surplus and crediting Inventories. Failure to make this adjustment would result in the combination's showing current assets at an improper figure and would be equivalent to the carrying of inventories by any single company at an inflated valuation. In order to obviate the difficulty of securing the necessary figures for this adjustment, a method of accounting has been developed in consolidated companies by which the intercompany profit is shown on the books at all times. This profit is carried through the accounts as a separate item from the original cost until the finished product is eventually sold outside the con- solidation. While accomplishing this result the method permits each subsidiary to take up its own profits, to which it is legally entitled. The following example outlines the method in brief: Company A produces a raw material and sells it to Company B at a profit of, say, 10 per cent; Company B converts this raw material into a partly finished product and ships it over a Railroad C, owned by the consolidation, to Company D, by whom it is fur- ther manufactured and finally sold to outside parties. Company A produces material to the cost value of $100,000, and sells $20,000 of this to outside parties, $60,000 to Company B, and has the remaining $20,000 in stock. Company B buys material from Company A, costing $60,000, for $66,000; spends $34,000 in further manufacture; ships $70,000 of the manufactured product over Railroad C to Company D; sells $20,000 to outsiders, and has $10,000 in stock. Company D purchases products from Company B, costing $70,000, for $77,000; pays $5,000 freight to Railroad C which costs the latter $3,500; expends $18,000 in completing its manufacture; sells $80,000 of the finished product to outsiders, and has the remaining $20,000 in stock. The books of Company A require no special entries. Ch. 34] CONSOLIDATED STATEMENTS 1383 In Company B's books its Manufacturing account will stand as follows: I. C. ist Profit Cost Total Cost of material $ 6,000 $60,000 $ 66,000 Manufacturing cost 34,000 34,000 $ 6,000 $94,000 $100,000 'Cost of sales: To outside parties $ 1,200 $18,800 $ 20,000 To Company D 4,200 65,800 70,000 Balance in stock $ 600 $ 9,400 $ 10,000 In company D's books the Manufacturing account will be dealt with similarly, as follows: I. C. ist Profit Cost Total Cost of material per Company B $11,200 $65,800 $ 77,000 Freight 1,500 3,500 5,000 Manufacturing cost 18,000 18,000 $12,700 $87,300 $100,000 Cost of sales: To outside parties 10,160 69,840 80,000 Balance in stock $2,540 $17,460* $20,000 The subsidiary companies will take up in their Income accounts the whole of their profits on their sales, and will declare dividends in the usual way. Out of the dividends it receives, the holding company will set up $600 in respect of B's profits, and $2,540 in respect of D's profits, or a total of $3,140, which will be credited to an inventory reserve. In this way, all stocks on hand of all com- panies are, on the consolidated balance sheet, carried at net cost within the consolidation, and the consolidated income takes up no profit except on sales made to outside parties. If any of the pro- duct is used for construction work within the organization, the net cost only is used, so that no profit of subsidiary companies enters into capital expenditures. 3 ' By permission from Accounting Practice and Procedure, by A. Lowes Dickinson, pp. 180-182. CHAPTER XXXV CONSOLIDATED STATEMENTS (CONTINUED) 369. When to Use Consolidated Statements When the holding company owns all of the stock of a sub- sidiary there is no question regarding the need of a consolidated balance sheet. If it owns 51% there is seldom doubt as to the advisability of the consolidated statement. But what if it owns a minority? If that minority holding is yet sufficient for effective control, few perhaps would question the wisdom of joining the statements. If the holding company, however, is not able to exercise control there is a question as to whether the statement should be joined. The rule might be laid down that if the stock of the other company forms an important percentage of such a holding company's assets, no balance sheet except a consolidated one would satisfactorily present the holding company's condition, but that a statement for the other company would be adequate without consideration of the holding company. The stock- holders of the subsidiary have no interest in the holding company in the way in which those of the latter have in the subsidiary because of its ownership of stock in the subsidiary. No definite rule can be promulgated. This fact has been recognized by the Bureau of Internal Revenue, which requires the disclosure of affiliations when the intercompany stock ownership is in excess of 50%. The question of whether or not accounts of affiliated companies should be consolidated is to be decided on the merits of each particular case, basing that decision' on the answer to the question as to which form of statement will more fully show the true financial condition of the com- panies. This alone can be the final test in doubtful cases. 1384 Ch. 35] CONSOLIDATED STATEMENTS 1385 370. Basis of Consolidation There are two methods of preparing the consolidated balance sheet when the holding company does not own all of the stock of the subsidiary, under which the consolidated statement shows: (i) Either the holding company's proportionate share only of each asset and liability of the subsidiaries; or (2) all the assets and liabilities of the subsidiaries, bringing over on the liability side of the consolidated balance sheet the outside interest in the capital stock and surplus of the subsidiaries. The second is the customary method, and it should be readily apparent that it is the better method of showing the financial position of the consolidated companies. The inclusion in the consolidated balance sheet of 80% of the assets and 80% of the liabilities of a subsidiary company does not present the true condition. It seems far more reasonable to show all the assets and all the liabilities as belonging to the group, which as a group has a capital liability to outsiders for the par value of their stock and for the share of the surplus represented by that stock. Further, if a holding company has an account receivable of $1,000 due from the subsidiary, and if there is shown in the consolidated balance sheet that percentage of the assets and liabilities of the subsidiary company which the holding company owns of the subsidiary's stock, there would be an intercompany item of only $800 (80% of the stock being owned by the holding company), and it would be necessary to treat the additional $200 receivable as an account due from outsiders. A consolidated balance sheet prepared in this way shows the holding company's own assets, liabilities, capital stock and surplus, and its proportion of the assets, liabilities, and surplus of the subsidiaries, but it does not contain all the information necessary to a satisfactory statement, in that it understates the assets controlled by the consolidation and ignores certain liabilities which, although applicable to the minority interest, may yet have to be financed by the holding company in order to maintain its own standing and organization. 1386 CORPORATE ACCOUNTING [Bk. III- 371. Showing Minority Interest as a Liability These disadvantages do not apply to the second method of preparing the consolidated balance sheet when the holding company does not own all of the stock of the subsidiary, under which all the assets and liabilities of the affiliated companies are shown (with intercompany items eliminated), the outside interest in the capital stock and surplus of the subsidiaries being shown as a liability. Taking the example given in the preceding chapter in which the intercompany items have already been eliminated, 1 a form of balance sheet made out according to the second method is shown in Form B which follows. A comparison of the two forms will show exactly how the latter balance sheet has been prepared. The source of the various figures having to do with capital stock will be readily apparent. The manner of dividing the surplus is shown in the following table. The figures can easily be traced back to the balance sheet and adjustments in Form A. Company X (the holding company) has a surplus of $ 81,200.00 Company X owns $i 75,000 of the $300,000 stock of Company Y and is therefore entitled to 175,000/300,000 of its surplus of $74,100 43,225.00 Company X owns all of the capital stock of Company Z and is therefore entitled to all of its surplus of 34,400.00 The surplus owned by the affiliated companies is therefore $158,825.00 The surplus of the outside interests is only that proportion of the surplus of Company Y which the outside interests own of the capital stock of Company Y, or 125,000/300,000 of $74,100, or $30,875. The outside interests have an interest also in the surplus of Company X which might be shown. If one-twentieth of Com- pany X's surplus, or $4,060, belongs to Company Y, then the minority interests of the latter company own five-twelfths of this surplus, or $1,691.67. 1 See Form A, page 1379. Ch., 35 ] CONSOLIDATED STATEMENTS 1387 o o o o o O O Q O O O O O w *"* to 10 d^ "-^ d^ o" r^. M w t^- oo 00 Tf H Tf M M 1 ^ ^ G " G O ^H O ij C/2 ' O CJ M C 2 ^ o T) I>% CJ kj ^'^ . ^ OJ -4-> a C T) W o "*|T "Q SHEET BSIDIARIES irately intercom |.g .a J'S S.i S "^ *~^ r^ CH ^^ ^H oO (fl >,& *'<^i ^g 5^2 1^ o 3 tfl rt -^ c 2(u "0^ ^TST) ^4n. ^Oq3 'S 3 H < ~ M g- O* [fl 3 . S -5^ " Gas -W to O +-> 45 ,T3 (-1 O. O o.K.5 y&S G t-3 a a o o PQ Ucc PQ P M - W ~" Q < W pq i-, a o W bO O O O Q O O Q O 8 a g U Q 1 C?^ fO CT tC cs \o w f > * > Tf W 1O o" 00 M o I w ) ^ i-T fe S ( 1 |^ " O u o o 1 o U C/l j t/) H3 s o> 2 1 -^ _ S "5 U 42 S 8 "i "H ' Q- | o JS) $ ^ Jj J^ ^ M C/3 jS^^g^U |ljl W | 'o,"2 &Q ^ rt ^ j3 c/i *^( *O ^ uT rt ^ Q" * a Js-l | Illlll 1388 CORPORATE ACCOUNTING [Bk. III- 372. Combined Balance Sheet Form C, which follows, might be called a combined balance sheet. It is a combination of the assets and liabilities of several closely affiliated companies without any cancellation of inter- company debits and credits. The items are arranged very much as in the fourth column of Form A; in fact, where only two or three companies are concerned, the combined information might be presented in a columnar exhibit comprising the first four columns of Form A as they stand. Among the assets are included $60,000 of advances to sub- sidiary companies and $27,000 of intercompany debts, the latter included with the sundry assets. These are likewise shown as offsetting liabilities. Taking the entire matter as one concern, it will be seen that the company owes $87,000 to itself. Such a statement as this is not favored because it does not show readily the true worth of the group or its quick assets and current liabilities. It is a makeshift at the best, and cannot truly be called a consolidated balance sheet. The word "com- bined" seems to describe it best. Accountants sometimes consolidate only the accounts of the subsidiary companies, the balance sheet of the holding company being presented separately in the ordinary or unconsolidated form, but what advantage there is in such a practice is hard to see; its disadvantages are obvious. FORM C CONSOLIDATED GENERAL BALANCE SHEET OF COMPANY X AND SUBSIDIARIES Y AND Z DECEMBER 31, 1921 (Presenting all accounts and intercompany details without cancellations) Assets Plant and Capital Assets $ 429,800 Cash and Sundry Assets 290,100 Material, Supplies, and Goods in Process 510,000 Prepaid and Deferred Charges 77,900 Ch. 35] CONSOLIDATED STATEMENTS 1389 Advances to Subsidiary Companies 60,000 Investments in Stocks and Bonds of Affiliated Companies* 430,000 Total Assets $1,797,800 Liabilities Capital Stock Outstanding: Of Company X $500,000 Of Company Y 300,000 Of Company Z 200,000 $1,000,000 Bonds of Company Y 50,000 Current Liabilities 471,100 Advances and Intercompany Obligations 87,000 Combined Surplus 189,700 Total Liabilities $1,797,800 * The investments may be stated separately if desired. 373- Additional Illustrations of Consolidated Balance Sheets The balance sheet of the Vulcan Machine Works and its subsidiaries (Form D) , which follows, is that of a manufacturing company, and shows an arrangement of details slightly different from those of Forms B and C. It will be noticed that the company's bonds to the value of $50,000 are included in the assets and also in the liabilities, this amount being owned by a sub- sidiary. The stockholdings are indicated as a memorandum on each side, while the stock premium is included in the assets, thus indicating that the stock owned is worth more than par. This premium might be charged against Surplus. If stock is purchased below par, the discount may be credited to Surplus, provided the stock is really worth face value. A deficit of an underlying company should be shown in the consolidated balance sheet as a deduction from Surplus. I3QO CORPORATE ACCOUNTING [Bk. Ill- 1 ,,;; | 3 "3 g g < ^3 o_ o. o. T3 10 CO ^ oT c O4 M 3 -i^-fl 4$ s o T3-: Q ^ J 1. : G S r \ o3 < ^ - M ii D RAL BALANCE SHEET KS AND SUBSIDIARY COMPJ CHER 31, 1921 Liabili First Mortgage Bonds: 6% Bonds of Vulcan thorized and Issued . . (Of this amount $50, V\1T fllV\fl^llO t-*T />rt-"f\0 uy ouuaiuiai^ ^um^cuj Current Liabilities: Accounts Payable. Dividends Declared bj pany Bond Interest Accrued , Intercompany Accounts: (Owing to affiliated omitted per contra, 3 W fc n g t, w ^ u O Q O p Q u-> 3; Q 2 (V. H *2 W go ^ S . en ^ 9 g < g g g g g o ^~J . - o o o_ M O o o" o" *o ^ <3 10 co 1O O H o ^ \O^ PO M u g & > ^cj en ,3 -O rj it ? C Jj r/l V 3 *"" i^ *^ 5 G gO^lj ^ >3 W T3 co S P & pq co p \ 4 u M Ch. 35] CONSOLIDATED STATEMENTS 139' 8 o Q O 8 q. o M M s 1 8 00 * * 88 C* OO ^^ 8 8 2~8 rt -O 8 \o" o" M o o ro "5 g a Q o O^ 4> i tn 3 M 4J < 4) 1 la *rt c SH CM O O w 2 O O r i [/i ^ "2 C i ^^ ^ M ^ 1 1 b^ll "o s ^ i us S r2 J^ ** 3 3 o i i ^ S3 n "9 So :A ? T3 ^ "^ 3 "S M J3 indry Reserve! For Adjustme For Bad Debt apital Stock: Authorized ar Common. . .Preferred. . o "> o * o""" 3 yj '0,3 2 C/J Ci ^PP PH >resented on bot i of the preferred * U M lH -M 8 8 || q M rl i-T >0 * -0 C go 5- * c p 5 A *- S* 80 '"o o "2 " o o o r 10 *? er> * |1 C* M .l 8S >.'C 9 o ;>Q c />. * '2 2 V 3 S3 o C- O o P |^ o o" tn s O .S " " ^ '/, H O ' O 4> fc Available Assets: Inventories Accounts and Notes R( Cash in Banks Intercompany Accounts: (Obligations of Affiliatt omitted per contra, rr,f_j /-M For Affiliated C'ompan Miscellaneous:* Dividends Declared Scott Company. . . . Accrued Interest on B Subsidiaries Good-WUl. . * The dividends'and tl ** The share of surplus o I3Q2 CORPORATE ACCOUNTING [Bk. Ill- c/3 5 I | 1:3 o b cd * ll & W u S 5 ^ CJ 6 w -5 >- a o g o o 3 o O < hjQ w o,s o a 8 ^ 9 J H >-J 1-1 C ) O O -4- . en tn _ *J NX OCA) ^ 8^ 81 a +j O >. -9 e -> o eo o c/3 *- rj -r i _ C/3 >-i w w r O D 02 0} r/5 c^xi'C ..'C-a ^3 S .2 ts.2 *j rt-s ^."S^rs >> ( CO r s^ "a-s M a g, o '-35 1-8 -l ^ rt S If -oO C rC ^g * >H 4) lil -t3 CL, .a gtg g 5" all g^g^ 3 >S o :. |B Cb. 35] CONSOLIDATED STATEMENTS 1393 I 1 o 8.1 s, :* ^ I OJ :J as c :1 aj|-8jo* Si.Sl8'M lilllll w g w)!5G-K u .200 s l 1394 CORPORATE ACCOUNTING [Bk. HI- The division of surplus profits between the holding company and outside interests must obviously depend on the status of the preferred stock. The holders of that stock may or may not have an interest in excess profits over and above the dividend payments; therefore no division is attempted in this exhibit. Another consolidated balance sheet, shown in Form E, is that of the Minnesota Lumber Company which owns and operates ten retail yards and four subsidiary companies. In connection with this statement underlying details having to do with the separate yards of subsidiary companies are contained in support- ing schedules not reproduced here. Each schedule assembles all of the items of a similar nature on hand at the various yards and companies. For example, Schedule i would show the cash and book balances, or overdrafts, at the various yards and companies as well as at the home office. Schedule 4 would in like manner show the location of all merchandise inventories and supplies of the various yards and companies. Otherwise the balance sheet differs but slightly from the other forms pre- sented in this chapter. By placing the capital and surplus profits after the liabilities instead of before, it is possible to show the "net worth" of the combined companies. As a further illustration there is presented on pages 1396-97 a consolidated balance sheet of the United Equipment Company and the Nelson Car Wheel Company, the combination of which was used as an example in the study of holding com- panies. 2 It will be seen that this consolidated balance sheet includes only the two stated companies, the United Equipment Company's holdings of stock in other companies being shown in the Investments account. It is obvious, however, that this account would not include the stock of companies whose state- ments are included in the consolidated balance sheet. The investment of the United Equipment Company in the bonds of the subsidiary is deducted from the Investments account and * See { 263. Ch. 35] CONSOLIDATED STATEMENTS 1395 added to the amount of bonds in the treasuries, being thus deducted from the liabilities. 374. Consolidated Income Statement The profit and loss accounts of the parent company and its various subsidiaries may, like the balance sheets, be combined in one comprehensive income statement or statement of profit and loss. This is a simpler process, however, than the prepar- ation of a consolidated balance sheet, since there is no minority interest to work out. A columnar work sheet is generally used in combining the various items of income and expense, as already illustrated under the balance sheet. In principle the consolidated profit and loss statement simply groups and totals similar items of income and expense. There are, however, certain eliminations to be made which are related directly to the asset and liability accounts (other than the consolidated surplus) and some which do not affect the surplus. Among the former will be found the adjustment previously discussed whereby any profit made by one company in the group, on merchandise sold to and still in the possession of another, must be eliminated from the valuation of the in- ventory, which is to be carried at cost to the group as a whole and not at the selling price of the company which transferred it (which is its cost to the company which holds it). 3 375- Elimination of Intercompany Income and Expense Items This brings us to the fact that, for purposes of the con- solidated statement, sales, whether of products or of services, from one company in a consolidated group to another are not to be considered as sales any more than are shipments of mer- chandise from one branch house of a corporation to another, or transfers of merchandise or material from one department to another. In the consolidated statement such sales should be re- / See 361. 1396 CORPORATE ACCOUNTING [Bk. Ill- o o 80 i/> O Q Q Q Q Q C o? 8 8 > Sj 8 S > <^ xo o ^ w c* t- "^4 M a" ^ . * r w ? o . I U fi bo p i [^ C Ml o, . '-3 F SNT COMPANY EET AS OF JULY i, 1921 f the United Equipment Coi Wheel Company) S -C ^ . ^ > s P* "c 5 S Sg '^ ^ | i ^ ^ 0^3 U .3 8 J S 1 c^ 1j ^ I, J- ,-E 11 T3T3 CT3 rt g g c^ II I! o^ f,S| -3^.a 1 -tSi-tS H i;| a S^ S o ao S W g^pL,^ UP 0! C/} K) U Stock Owned by Others . Total Stock Outstan S W b s i 'w.ig OO OOQO OO oo o^-oo oo " O 1 P r3 o O w ^ ^O t" 1 ^t* CO^O **! .S'v o d "" << VO t> O ^"* OO ^O tO !/5 *O t^* OO ^ O"* O\ \O ^O coco tsoOOio coO* w "^ > * 1 *-* **-< O co tN cs M M . IH . . . . -i ....!).. O T3 "o c c ' ' ' ' 2 ' ' to "* O . '. . '. 2 d ^ " CH ' "6"^ ^-" ' rt -n -T-I ^ S ^ S ^ w c .& 1 rt a C 3s "g,W jg .> tO H o .S 3 ^O O W HI rf OO O H 00 O O "5 ^^B ^ 2 : s -s -a 8 l l N oOy.sgo^ ; o >o vO cs 1398 CORPORATE ACCOUNTING [Bk. III- moved from the aggregate sales of the consolidation and from the aggregate cost of sales of the consolidation. It will be evident that there will be no change on account of this adjustment in the profit of the group in connection with merchandise which has been sold out of the s group, because when the sale was made from one company within the group to another the selling price of the former became a part of the debits to income of the latter. On merchandise which has not been sold out of the group there will of course be that adjustment of profits on account of the changed inventory valuation which has already been discussed in relation to its effect on the balance sheet. Payments of interest, royalties, and other expenses from one company in the group to another should similarly be shown separately in the consolidated operating statement in such a way that they will offset each other instead of being included in both the income and expense of the consolidation. This adjustment will not, of course, affect the profit of the group as a whole, but will reduce its income and its expenses in equal amounts since any such amounts paid and received entirely within the group must have been equal. It is sometimes necessary to adjust the operating statements of the individual companies so that accruals and prepayments treated differently on the books of the several corporations may be handled alike in order exactly to offset each other. These suggestions will at least indicate the manner in which all intercompany transactions should be handled, the fact being kept in mind that the object of the consolidated statement is to show the operations of the entire group on the one hand with outside interests on the other. All transactions occurring purely within the group are to be taken out, so that the sales accounts, for example, are to show only sales to outsiders. CHAPTER XXXVI PREPARATION OF FEDERAL INCOME TAX RETURNS 376. Scope of This Chapter The income tax law at present in force is known as the Revenue Act of 1921. Under it there is provided a tax on all net "gains, profits, and income" resulting from every source. This law is generally believed to be only an interim act which, while it carried out the pledge of the party in power to remove the excess profits taxes on corporations, has not evolved a fully satisfactory substitute. The questions of what income is taxable, how its amount is determined, and what rates of tax apply thereto, open up a wide field to which many volumes have been devoted, and which cannot be touched upon here. Any brief rules which might be laid down would be subject to so many exceptions that they would be misleading rather than informative. This chapter will therefore discuss only the details of filling out the form on which corporations report the amount of their income. This report form is called the "return." 377. Excess Profits Taxes and Invested Capital For all fiscal years beginning in 1921 the excess profits taxes apply to corporate profits so far as those profits were earned in 1921, and do not apply to any profits earned in 1922 or thereafter. As a consequence of this fact there will be few original returns filed hereafter in which the excess profits taxes need be considered. Therefore, in a work of this kind, which is not intended to be a study of income taxation, there is no need of a discussion of those schedules of the income tax return which have. to do with invested capital, on which the excess 1399 1400 CORPORATE ACCOUNTING [Bk. 11 i- profits taxes were based. These schedules are the ones which have given taxpayers the most trouble, and the preparation of corporate returns will be greatly simplified by their elimination. It must be admitted, however, that other features which have been introduced in the Revenue Act of 1921 largely offset this benefit. 378. Services of Public Accountants The preparation of returns under the 1921 Act is so simplified that more corporations will be able to prepare returns satisfactory to the Bureau of Internal Revenue without calling in outside help. While this is true, it does not seem that the demand for the services of public accountants versed in income tax matters can be greatly decreased without disadvantage to the taxpayers. Over 90% of the problems in taxation worked out by public accountants have been in the determination of what constitutes net taxable income rather than what constitutes invested capital, and these problems still remain. Corporations generally will therefore continue to find advantageous the employment of competent accountants to assist them in showing their correct net taxable incomes, as they will thereby avoid overpayment of tax on the one hand, or underpayment with consequent future assessment of penalties and interest on the other. 379- Form of the Return The return is filed on Form 1120 of the Bureau of Internal Revenue. The forms to be used for taxable years beginning in 1922 have not yet been issued by the Bureau, so that for the present purpose it will be necessary to deal with the form in use, omitting, however, the calculation of the invested capital and of the excess profits tax. It is probable that the form adopted for returns of years subsequent to 1921 will not differ materially from the present Form 1120, except in the omission of these obsolete features and the necessary changes in the method of calculating the tax. : REV CORPORATION INCOME AND PROFITS TAX RETURN FOR CALENDAR YEAR 1921 Pago 1 of Return SHOO) Euiwol b, THIS RETURN SHOULD BE FILED NOT LATER Or for period begun , 1920, and ended , 1921 V. THAN THE 1STH DAY ^ nnT PLAINLY CORJORAJION'S NAME AND BUSINESS ADDRESS (Casfctar-. Stunp) OF THE THIRD MONTH FOLLOWING THE CLOSE (J f f OF THE TAXABLE PERIOD CASH CHICK M.O. COtT. 0V tNA, KIND OF BUSINESS ^._-W.i_!^#..?^/^rg-_^___ , IS THIS A CONSOLIDATED RETURK SCHEDULE A TAXABLE NET INCOME. CROSS INCOME. ar>rtU_,L 1. Gross sales, less returns and allowances . > S3O.OOO>OO\ 1. Usi cost of goods sold, exclusive of item, called for separately bolow' (from Schedule A2)_ ?. PP.. 7. Royalties , . 8. Share ol net income earned by personal service corporation (whether received or net) , 9. Dividends on stock of foreign and domestic corporations SbueflXifrpK'fluKelacaiV i ,-|/i7r" 10. Gross income bom all other sources' (not including any amount reported in Item 23;below)(from Schedule A10) I l.l.ToP.. PP.. 11. TOTAL or IIIKS 1 TO 10 ... ., , DEDUCTIONS. I I 12. Expenses (except amounts reported in Item 2 above, or called for separately below) (from Schedule A12) $ \...J&\&2Q.. P.P.. 13. Compensation of officers (in whatever form paid) (from Schedule A13) __.L.-LS.W L? 19. Depletion (from Schedule A19) ! . ' I l_ 20. Amortization ol war facilities (from Schedule A25) . 1 ...J '._ L 21. TOTAL or ITEM 12 TO 20 a, t _U5. g$Q. Si. . ITSM 11 nnnji In- n ._... ( ,!?. 5.5.0.i.e.0_ 23. 1-ront or loss on sales of capital assets and miscellaneous investments (from Schedule A23) _J*__ I |..TJ2' 235; .PP.. 28. Dividends deductible under Section 234(a) of the Revenue Act of 1921, (from Schedule A26) '. L 27. HIT Icom (Item 25 minus Item 26) (II return is for a period less than twelve monfhe, see page 1 of Instructions, paragraph 10) ' L..PA. SCHEDULE B INVESTED CAPITAL. 1. Capital, surplus, and undivided profits at beginning of taxable period (from Schedule E, Item 11) ., 1 t. Plus adjustments by way of additions (from Schedule P, Item 4) I ..... 5. " 4. Less adjustments by way of deductions (from Schedule 0, Item 7 6. RxiuiNDia . i i 6. Hut or minus changes in invested capital during taxable period (net Increase or Decrease from Schedule H) _________ 7. TOTAL (on REKAINDXI) - 5. Less deduction on account of inadmissible assets (from Schedule J) SCHEDULE C-EXCESS PROFITS CREDIT. 1. Eight per cent ol invested capital for taxable period (Item 9 ol Schedule B) 2. Exemption ($3,000) (except lor a foreign corporation or a corporation satisfying the conditions provided in Section 2C2 of the Act) . SCHEDULE D-COMPUTATION OF TAXES. 1. SaACBxn. 1. Net Income, not in excess of 202 ol invested capital I.... 1. Totals computed under Section 01(o) \l--.~ II |_-_jl 1. U 1 --I- 4. Excess Profits Tax, if computed under Sections 302, 303, StM(c) or 837 ol the Revenue Act ol 1021 (ace page 2 of Instructions, paragraph H) L 6. Net income (Item 27, Schedule A) 1 11. Income tax (10)6 of Item 10) _________ 12. If net income does not exceed 1-5,200, enter amount UfA i. . T-B** |f JJ gffif??'"' L I in exce-i of 125,000 . Total tax(ItemSoMthele"er.otS,plusItemsll and 12). 10. BaUncefIUn,lesslteM,7,aluH,orIt>m.<,. and 9). An amended return t be plalnlr marked "Amended." 18. Balance ol lax (Item minus Items U and 15) Check, and draft, will be .cc.pl td only If payable at par. I4OI SCHEDULE L. RECONCILIATION OF NET INCOME AND ANALYSIS OF CHANCES IN SURPLUS. I. Kal | >afMrrart ) i , W^j^^To^cbUcftUoiu of the United "Toa "ibiiciikoTorauies," >. Cbarft* ifaliut rtttrru f cr bed debts, If lUra IT, ciMdok A, Is adJltlou to a nemo .- . 4. OwiwacaiaMraterreiiorc' ii'""i "- ' r ptaftt irhsre tbi corporation is directly or Indirectly a beneBc&ry.... SCHEDULES TO BE FURNISHED IN SUPPORT OF ITEMS IN SCHEDULE A. The following schedules must be furnished, and those prepared oa separate shoeta should ho firmly attached to this return. Enter name and address of corporation on each sheet. M Iswe&tair.Fafm lUa.end < L;J n lines 3 and s.Immedl- CM. K'Ll^..... ; _...... ; ..., v . r .. : ... ; .. : . vS .J2lG.Ci2& ! .PO.. ...C-JxtJn.. ?o^..42o.-.og... 9-2iD,.a.lC>-..OQ.. Its OTHER ' prMrJJ SCHEDU1E A4! TAXABLE IHTXBEST OH UBXSTT BOHUS. ETC. i* intrtit on th. oblkationj Ibted to eoloina 1 of th tollowine ub! h wholly eTempt from corpontlni , ,,! i. -^?SS^ w3 r, i u,_Jr.o ,. ,., n MJdttai<> *mptkms, lV-0 prindpft \^ss?SgiSS3 *"," . P rtDdp.l (Ar^ . Trincipal Inwaat). US!SS? v;gRS 2. BO.OOO 3.1125,000 <. K.OOO column, I 2Tj,"nJ<- .:npllolis. , and First, Second, Third, and Fourth * 8eptamberl,1917(xcwptVlo- .KOKJ. Nont j SCHEDOT.1 A COMPENSATION OF OFTICntS. mon: (} uai compeaaaUon lor the Ubl period labor. tuppUea, evernead, and etnet tlmi property eh.tj prtncipallt M cUuiflcuioD or ropalia SM px 2 ..i.iij.i.iCi, - 6CHKDULE Al: TAXES. ! ix-i'i .. v'^hu rl .v.jr.f ^SSS2SsSSSMsS^^^^^S^S* ff SCHSDCIB A1S: EXHAUSTION, WEAR AITD TEAR (ladadl&t o Amount of d*prdaUon cborcwl 01 _ -jductioa Mtaca a AW: DEPLETION. If a deduction Is claimed on account of depletion , secure from the collector To Form F (inlKellaneMii noomeuti). Form O (oil and cat), or Form T (timber] * d .S^** ttolln * U " lnpr " V10USrea "' th . Inc on dedoottau or adtUdoai to Y*!U ot phyjlcal aswtiVlth *xplwiUon ( now depletion d able prtoJ hu U d:ermineJ. In M the undersigned^ Ux*blo pehod iu nuted, punuant to the Re 1 ff f the corporation for which this return ia made, being severally duly sworn, each for himself deposca and sa icnU, has been examined by him and ia. to the bost of his toovfadfi od belief, a true ami complete return toad* a Act of 1921 and the Regulatione issued under authority thereof. to and eubarribod before me this .. 1402 Ch. 36] FEDERAL INCOME TAX RETURNS 1403 380. Preparing the Return The easiest way to prepare the corporation income tax return is to work from the Profit and Loss account to the return and not to attempt to fill out the return in the order in which the items appear on the form. The various items of income and expenses will be shown in Schedule A on page i and Schedule L on page 4 of the return. Both these pages are shown in the following section. If the book closing has been made through a work sheet in the form ordinarily used by an accountant, the items in the "Loss" and "Gain" columns of that work sheet may be taken as they come, otherwise the various amounts closed into Profit and Loss will be taken from the journal entries. Let us consider the before-closing trial balance and work sheet which follow. It is assumed that all necessary adjustments have been made before the trial balance has been taken off. 381. Showing Items of Income It is usually easiest to enter first the items of income, which will be found as credits to the Profit and Loss account or in the "Gain" column of the work-sheet. The first of these is Net Sales, $390,000. It is to be entered on line i of Schedule A, as shown on the filled-in form which follows. Sub-Rental Income of $450 is similarly entered on line 6 of Schedule A. 382. The Supporting Schedules The next item, Profit on Sale of Vacant Lots, $1,250, belongs on line 23 of Schedule A, where it will be noted that a supporting schedule known as Schedule A23, is called for. A form for this supporting schedule will be found on page 4 of the return. This must be properly filled out so as to show that the net profit on the sale has been computed according to correct prin- ciples. Because we shall have another item which belongs in this supporting schedule, 1 we do not now enter the profit on line 23 of Schedule A. i See deduction for loss on sale of Liberty bonds, discussed in I 393." 1404 CORPORATE ACCOUNTING fBk. Ill X I M ' ' ' O fO X # fi M a a B -fc A A A A A , I A 91 ' 8 A \r~, A A 1^ A O M O W .; * cT O CO *O O O O O S O IO fO'O O COCO *-O H Q r-i M CS M -] to w o 0. H i-l [ _ _ _ AAAAAA AA A u W *M M ^ AAAAfSrS AA r?s c ' u oo o - In the caso of merchandise on hand at the beginning of the taxable year, the inventory price of such goods. (2) In the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash dis- counts, approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be added transportation or other necessary charges Incurred In acquiring possession of the goods. (3) In the case of merchandise produced by the.taxpayer since tha beginning of the t**frfrh year, (a) the cost of raw materials ana supplies entering Into or consumed In connection with the product, (>) expenditures far direct Irtcr, (c) Indirect expenses incident to ana necessary for the production or the partic- ular article, including in such indirect expenses a reasonable proportion of man- ocoment exponsjs, but not including any cost of selling or return on capital, whether by way of interest or profit? (4) In any industry in which tho usual rules for computation of cost ot pro- duction are inapplicable, costs may be approximated upon such basis as may b. reasonable and in conformity with established trade practice in tho particular industry. Among such cases are (a) farmers and raisers of live stock (see article 1586), (o) miners and manufacturers who bv a single process or uniform series of processes derive s product of two or more kinds, sizes, or grades, the unit cost of which is substantially alike (se article 1587), and retail merchants who us. what is known as tho "retail method " in ascertaining approximate cost. (Se article 1588.) ART. 1584. Inventories at market. Under ordinary circumstances, and for normal poods in an inventory, "market" means the current bid price prevailing at tho date of the inventory for tho particular merchandise in the volume in which ually purchased by tho taxpayer, and is applicable in the cases (a) of goods nts of cost (materials, labor, and y o axpayer, n s purchased and on hand, and (6) of basis elemens o cos maeas, aor, a burden) in goods in process of manufacture and In finished goods on hand; e clusive, however, of goods on hand or in process of manufacture for delivery upon firm sales contracts (I. e.. those not legally subject to cancellation by either party) at fixed prices entered into before the date of the inventory, which poods must be inventoried at cost. Where no open market exists or whore quotations are nominal, due to stagnant market conditions, the taxpayer must use such evidence of a fair market price at the date or dates nearast the inventory as may be available, such as specific purchases or sales by the taxpayer or others in rea- sonable volume and made in pood faith, or compensation paid for cancellation of contracts for purchase commitments, where the taxpayer in tho regular course of business has offered for sale such merchandise at prices lower than the current price as above defined, the inventory may be valued at such prices less proper allowance for selling expense, and the correctness of such prices will be deter- mined by reference to the actual sales of the taxpayer for a reasonable period before and after the date of the inventory. Prices which vary materially from tho actual prices so ascertained will not be accepted as reflecting the market. ART. 1585. Inventories by dealers in securities A dealer in securities who in his books of account regularly inventories unsold securities on hand either (a) at cost or (6) at cost or market, whichever is lower, or (e) at market value, may moke his return upon the basis upon which his accounts are kept; provided that a description of the method employed shall be included in or attached to the return, that all the securities must DO inventoried by the same method, and that such method must be adhered to in subsequent years, unless another be authorized by the Commissioner. For the purpose of this rule a dealer in securities Is a merchant of securities, whether an individual, partner- ship, or corporation, with an established place of business, regularly engaged in the purchase of securities and their resale to customers; that is, one who as a merchant buys securities and sells them to customers with a view to the gains and profits that may bo derived therefrom. If such business is simply a branch of the activities carried on by such person, the securities inventoried as hem provided may include only those held for purposes of resale and not for invest- ment. Taxpayers who buy and sell or hold securities for investment or specu- lation, and not In tho course of an established business, and officers of corpora- tions and members of partnerships, who in their individual capacities buy and sell securities, cro not dealers in securities within the meaning of this rule. A dealer In securities is not entitled to tho benefits of section 206 with reference to the gain from tho sale of securities. AXT. 1580. Inventories of live-stock raisers and other farmers. (1) Farmers may change tho basis of their roturnsfromthait of receipts and disburse- ments to that of au inventory basis, which necessitates tho use of opening and closing inventories for the year in which the change is made. There should b included In the opening inventory all farm products (including live stock), pur- chased or raised, which were on hand at the date of the inventory, but Inventories must not include real estate, buildings, permanent improvements, or any other assets subject to depreciation. (2) Because of thodifflculty of ascertaining actual cost of live stock and other farm products, fanners who render their returns upon an inventory basis may at their option value their Inventories for the current taxable year according to the "farm-price method" which provides for the valuation of inventories at market Elce less cost of marketing. If tho use of the "farm-price method *' of valuing ventorlcsforany taxable year Involvesachangoinmethodof pricing inventories from that employed in prior years, tho opening inventory for the taxable year in which the change is made should be brought in at the same value os the closing inventory for the preceding taxable year. If such valuation of the openinginven- tory for the taxable year in which the change is made results in p,n abnormally larpe income for that year, there may be submitted with the return for sucu taxable year an adjustment statement for the preceding year based on tho "farm- price method " of valuing inventories; upon the amount of which adjustments the tax, if any be due, shall be assessed and paid at ihe rate of tax in effect for such preceding year. (3) Where returns have been made In which the taxable not Income has been computed upon incomplete inventories, the abnormality should be corrected by submitting with the return for the current taxable year a statement for the pre- ceding year in which such adjustments shall be made as are necessary to bring the closing inventory for tho preceding year into agreement with the opcninc complete inventory for the current taxable year. If necessary to reflect the in- come.similaradjustrnents may be made asat the beginnins of the preceding year. and the tax, if any bod ue shall be assessed at the rate of tax ineflect for such year. Ait. 1587. Inventories of miners and manufacturers. A taxpayer engaged in miniug of manufacturing who by a single process or uniform series of processes derives a product of two or more kinds, sizes, or grades, the unit cost of which is substantially alike, and who in conformity to a recognized trade practice allocates an amount of cost to each kind, size, or grade of product which in the aggregate will absorb the total cost of production, may use such allocated cost as a basis for pricing inventories, provided such allocation bears a reasonable relation to the respective selling values of the different kinds of product. ART. 15S8. Inventories of retaU merchants. Retail merchants who em* plo? what is known as the "retail method " of pricing inventories may make their returns upon that basis, provided that the use of such method isdesignated upon the return, that accurate accounts are kept, and that such method is consistently adhered to unless a change is authorized by the Commissioner. Under this method tho goods in the inventory are ordinarily priced at the selling prices and the total retail value of the goods In each department or of each class of goods is reduced to approximate cost by deducting the percentage which represents tha difference between the retail selling value and the purchase price. This percent- age is determined by departments of a store or by classes of goods, and should represent as accurately as may be the amounts added to the cost prices of tha goods to cover selling and other expenses o( doing business and for the margin of profit. Incomputing the percentage above mentioned, proper adjustment should A taxpayer maintaining more than one department In his store or dealing In classes of goods carrying different percentages of gross profit should not use a percentage of profit based upon an average of his entire business, but should compute and use in valuing his Inventory the proper percentages for the respeo- tlve departments or classes of goods. s i:aia I4IO Ch. 36] FEDERAL INCOME TAX RETURNS 141 1 porations the officer who signs the principal certificate is, of course, often the man who is also responsible for the taking of the inventory, in which case the subsidiary certificate need not be filled in. The instructions on the reverse of the form are probably clear. 389. Schedule Ai2 Expenses The next item in the "Loss" column of the work-sheet is Wages, $26,600. This and all items of expense for which specific spaces are not provided in the lower half of Schedule A will be included in the total to be entered on line 12 of that schedule. In accumulating this total the method least likely to result in errors necessitating a checking back, is to head up a sheet of work-paper with the title "Schedule Ai2 Expenses," record the item Wages, $26,600, and then not try to finish the schedule at once but proceed down the "Loss" column of the work-sheet or the journal entry debiting Profit and Loss, placing the various amounts where they belong as they are reached. The items of Delivery Expenses, Warehouse Rent, and Ware- house Expense, which come next, will all be entered on Schedule Ai2. BRYANT-CHASE COMPANY Indianapolis, Indiana 1921 SCHEDULE Ai2 EXPENSES Wages $26,600 Delivery Expenses 2,300 Warehouse Rent 2,500 Warehouse Expense 460 Discount on Sales 3,630 Traveling Expense 8,890 Office Expense 4,600 Advertising 16,000 Miscellaneous Expense 3,4 Light and Heat 54 Insurance 600 $69,520 141 2 CORPORATE ACCOUNTING [Bk. III- 390. Schedule Ai8 Depreciation The next item is Depreciation, $12,610. The amount is entered on line 18 of Schedule A, and the facts from which the depreciation was calculated are recorded on Schedule Ai8, page 4 of the return. It should be noted that the cost of each asset, divided by the probable life, is expected to be the amount of depreciation taken on that asset during the year. If increases have been made in the asset account during the year, as for example by the purchase of additional machinery, it is expected that depreciation will be taken on the average between the cost at the beginning of the year and the cost at the end, unless depre- ciation can be readily calculated on the additions for the period for which each was in service. There is nothing in the law or the regulations to prevent depreciation at proper rates being separately calculated on each individual unit of equipment, as is often done when a property record is kept. The cost total on Schedule Ai8 is expected to equal the bal- ance sheet asset valuation, and the total of the depreciation taken in the current year and in previous years will normally equal the amount of the balance in the Allowance for Depreciation account. There are, however, many things which may disturb this recon- ciliation. 391. Entry of Other Expenses The next item in the "Loss" column, Discount on Sales, $3,630, will be entered on the schedule of expenses (Ai2) which we have started. Officers' Salaries, $18,400, will be entered on line 13 of Sched- ule A, and a schedule of these salaries will be typed with the heading "Schedule Ai3 Compensation of Officers." This sched- ule will show for each officer the information asked for on page 4 of the return. Traveling Expense, Office Expense, Advertising, Miscellane- ous Expense, and Light and Heat, will all be listed on Schedule Ai2. The Miscellaneous Expense account has been used too Ch. 36] FEDERAL INCOME TAX RETURNS 1413 freely by the corporation whose return we are preparing. When the office audit of this return is made, it is likely that the com- pany will be asked to furnish an analysis of the items making up this total. As this request may not come until some years later, difficulty may then be experienced in furnishing the details. Generally speaking, the Miscellaneous Expense account should be used so sparingly that its total for a year will not reach $1,000, more specific accounts being opened to take care of items which would otherwise run it above that figure. Repairs, $1,120, will be entered on line 14 of Schedule A, and a separate schedule entitled "Schedule Ai4 Repairs" should be prepared showing the nature and amount of the principal items included in the total. Repairs is another account which should not be allowed to become a burying ground, because if it appears too large it is probable that the Department will ask to have it analyzed in order to make sure that additions to capital assets have not been charged off. It is better to open enough accounts to avoid these analyses at later dates. Deductible interest will be entered on line 15 of Schedule A. Insurance expense goes on the supporting Schedule Ai2. 392. Entry of Taxes, Donations, and Bad Debts Taxes which are deductible 3 are entered on line 16 of Sched- ule A, and a supporting schedule entitled "Schedule Ai6 Taxes" should be prepared showing the kind and amount of the various taxes claimed as a deduction. Federal income and profits taxes charged against Profit and Loss of the year should be entered as item 13 (b) of Schedule L on page 4; if, however, such taxes are charged to Surplus, their amount should be en- tered as item 16 of that schedule. Donations are entered as item 13 (a) of Schedule L, donations by a corporation not being deductible. The deduction for bad debts charged as a loss during the year * See Sec. 234 (a-3) of the Revenue Act of 1921. 14 14 CORPORATE ACCOUNTING [Bk. Ill- is entered on line 17 of Schedule A, and the information asked for in that connection on page 4 of the return should be furnished in a separate schedule to be prepared and entitled "Schedule Aiy Bad Debts." If the amounts charged off represent specific losses, the taxpayer must be prepared to show that the claim of loss is justified ; if the deduction is on account of an addition to a reserve for bad debts he must show that its amount is reason- able. 393- Completion of Supporting Schedules The last item in the "Loss" column of the work-sheet is the amount of a loss sustained on the sale of Liberty bonds. This must be entered on Schedule A23 as was the profit on the sale of vacant lots. The loss will be entered in red ink. The net gain on the sale of capital assets will then be obtained by subtracting the loss from the profit previously entered, and will be carried over to line 23 of Schedule A, and also (since there is no amount on line 24) to the last column on line 24. The forms to be used for 1922 and subsequent years may handle differently the gain or loss on sales of capital assets. Schedule Ai2 will then be added and its total entered on line 12 of Schedule A. Every supporting schedule should bear the name and the address of the taxpayer, at least to the extent of showing the city and state. It should also show the year to which it applies, as the schedules sometimes become detached from the return. If the taxpayer has a fiscal year other than the calendar year, the schedule should show just when such fiscal year ends. When the return is finally finished, all the supporting sched- ules, including Form 1126 (the Certificate of Inventory) should be firmly stapled to it on some page other than the first. As long as the four-page returns are in use, page 2 is probably the best place. If, as is expected, the returns for 1922 and subsequent years are two-page returns, the schedules should be stapled to the back of the return. Ch. 36] FEDERAL INCOME TAX RETURNS 1415 394. Completing Schedule A To complete Schedule A, the total of items i to 10 inclusive should be placed on line n, and the total of items 12 to 20 inclu- sive on line 21. The difference between these two totals should then be entered on line 22. To it should be added the amount previously entered on line 24, and the sum placed on line 25 and again on line 27. 395. Reconciliation of Income and Analysis of Surplus The net taxable income as shown on line 27 of Schedule A is then entered as item i of Schedule L, and the total of items i to 4 inclusive of Schedule L is recorded on line 5. The total of item 13 is recorded on line 14 and also on line 6, and is then subtracted from the amount shown on line 5, the difference being entered on line 7. If the work has been done correctly, this difference will be the amount which has been credited to the Profit and Loss account during the year. In the present instance the amount on line 6 is larger than the amount on line 5 and the difference, as a loss, should be entered on line 7 in red ink. As a proof that the increase or decrease in the net worth of the corporation has all been accounted for, Schedule L is con- tinued as an analysis of the changes in the Surplus account dur- ing the year. The Surplus at the close of the preceding year, as shown by the balance sheet submitted with the income tax re- turn, is entered as item 8 of Schedule L, and is added to the profit (or diminished by the loss) shown on line 7, the sum (or difference) being entered as item 10. If any credits of non- taxable income to Surplus on account of the return of amounts of surplus previously appropriated, 4 or from other sources, have been made during the year, these would be entered as item 9 and included in the total on line 10. Debits to the Surplus account during the year on account of dividends, additions to reserves which as non-operating reserves 5 4 See Ch. Ill, "Reserve Accounts." See i 17. For handling of income credited directly to such reserves instead of passing through the Profit and Loss account, see I 383. 1416 CORPORATE ACCOUNTING [Bk. Ill- are not deductible, etc., are entered as items 15 and 16 of Sched- ule L. Their total is entered as item 17 and also as item n. The difference between this item and item 10 is entered on line 12, and must be the amount of surplus as shown by the balance sheet as of the closing date of the taxable year which is being reported. 396. Completion of the Return To complete the return a schedule entitled "Schedule K Balance Sheets" explained on page 3 of the return (not shown among the forms of this chapter) should be prepared showing in parallel form the balance sheets of the corporation at the begin- ning and end of the taxable year. The balance sheet at the be- ginning should agree with that which was filed as the balance sheet at the end of the preceding taxable year. All the information specifically called for under the heading "Questions" on page 3 of the return (not shown) should be fur- nished, the copy for filing should be prepared, the schedules should be attached, and when the return has been subscribed and sworn to by the two proper officers it is ready to be filed, accompanied by a check for at least one-fourth of the tax shown to be due. 397- Consolidated Returns The preparation of consolidated returns is not different from that of other corporate returns, but attention is called to the fact that Form 1122, shown below, must be filed for each of the subsidiary companies whose income is included in the income reported by the holding company. I IIH-UNITED STATES INTERNAL REVENUE SERVICE INFORMATION RETURN OF SUBSIDIARY OR AFFILIATED CORPORATION WHOSE NET INCOME AND INVESTED CAPITAL ARE INCLUDED IN RETURN OF A PARENT OR PRINCIPAL REPORTING CORPORATION FOR PURPOSES OF INCOME AND PROFITS TAXES FOR CALENDAR YEAR 1921 V return it for calendar 1921, fife it on or be- fan March 15, 1922, with Or for period begun ...... ,1920, and ended ...,1921 _. _ . -^ (Date Received) which the Subsidiary or Affiliated Corporation hu II lor a period other than (N " ne) * calendar year, the return should be filed on or before (Street and number or rural route) the 15th day of the thW (Post Office and State) ol tuch period. 1. Date incorporated ___________________ : ___ ............................... Under lawa of what State? ___________________________ 2. Kind of business _______ ..... _________________________________________ .......... ____ __________ 3. Par value of capital stock outstanding at beginning of taxable period: (a) Common, $.. _______ . _______ ._......_..; (6) preferred, S ........ ____ - 4. "Name of parent corporation ............................................................ -------------- , _ 6. Address of parent corporation.......... ___ .................... ___________ ............................................_ _____ 6. Internal revenue district in which consolidated return has been filed ____________ .................................. ____ (Oive district, or city and State) 7. The department prefers that the entire tax shown on a consolidated return be paid by the parent or principal reporting corporation, instead of being apportioned among the corporations composing the affiliated group. If apportionment is made, state the amount of income and profits taxes for the taxable period to be assessed against the subsidiary or affiliated corporation making this- return ........ ____________ S ______________________________ We, the undersigned, president and treasurer of the above-named subsidiary or affiliated corporation, being severally duly sworn, each for himself deposes and says that the foregoing return, including the accompanying list (if any), has been examined by him and is to the best of his knowledge and belief a true and complete return of information made in good faith pursuant to the Revenue Act of 1921 and the Regulations issued thereunder. SWORN to and subscribed before me this ___ ____ ...... day of ________ ............. __ , 1922 .................................................................... _ ___________ President. (8! jniituri ol often mminuurinr. tuo 1417 1418 CORPORATE ACCOUNTING [Bk. III- 398. Information at the Source Attention should be called also to the two forms given below. These must be sent directly to the Commissioner of Internal Revenue so as to be in his hands not later than March fifteenth of each year. These forms cover the transactions of the calendar year, irrespective of when the taxable year of the person or cor- poration filing them ends. They are known as Forms 1096 and 1099, and their purpose is to inform the Commissioner of amounts of income paid to and in consequence ordinarily returnable by other taxpayers. Form 1099 is a small form on which the payer reports any amounts of "salaries, wages, rent, interest, or other fixed or determinable gains, profits, and income" in excess of $1,000 to any individual, partnership, corporation, etc., during the preceding calendar year, using one blank for each person to whom such payments were made. The method of filling out the form should be clear from the form itself. Form 1099 is in substance a letter of transmittal to accom- pany the smaller report forms. It is to be headed up with the name of the taxpayer making the statement and is to be filled out only to the extent of showing in Block B the number of re- port forms 1099 which are attached. It must be subscribed and sworn to by a proper person before forwarding to the Commis- sioner. Any officer of a corporation may make the affidavit. For purposes of collecting the information required for the proper filling out of these forms, a card such as that reproduced below has been found very useful. Such a card is also of service in the matter of adjustment of workmen's compensation, etc. The reverse side of this form contains a similar "record of payments" for two additional years, so that each card serves for three years. 3~s w tjj O O'-Z s 7S ! a t3 O $1,0 O fc >M . i I ot^'cS'^ S.9!3 M Mlllillll 1419 TJKITSD STATES INTERVAL REVENUE SERVICE ANNUAL INFORMATION RETURN OF PAYMENTS OF INCOME, ETC., REQUIRED TO BE REPORTED UNDER REVENUE ACT OF 1921 FOR CALENDAR YEAR 1921 (R.turn for Fi,c.l Y.r C.n Not B. Acc.pUd) FOR INSTRUCTIONS SEE REVERSE SIDE THIS RETURN, ( D,|, rKtlvtd |_ ACCOMPANIED BY SgrtUf SMUOH) REPORTS ON (Ntm< of person or orfuiii TO REACH THE COMMISSIONER OF INTERNAL REVENUE, (Street nd Dumber or rural route.) SORTING SECTION. WASHINGTON. D. C., ON OR BEFORE MARCH li. im. "" ~~ (OiyT) A B NUMBER OF CHARACTER OF INCOME PATD. ATTACHED. Interest, rent, salaries, wages, premiums, annuities, compensation, remuneration, emoluments, or other fixed or determinable gains, profits, and income of 91,000 or more (DO HOT WRITS IN THIS SPACE.) IMPORTANT NOTICE Vetnrns of Information are required to be rendered on the basis of the calendar year. Returns for any other period of time will not be accepted. If list showing names and addresses of payees is compiled or an adding machine tape used in executing Forms 1099. it should be submitted with forms. The name of the individual, corporation, partnership, etc., using Form 1099 may be printed or stamped on each; form, If so desired. Returns -of individuals on this form must be signed and Bwora. to by the individual or fail. duly authorized agent. Returns of corporations, partnerships, etc., must be signed and sworn to by an officer of the corporation or member of firm. I swear (or affirm) that to the best of my knowledge and belief the foregoing return and the accompanying reports constitute a true and complete statement of payments of the above-described classes of income made by the person or organization named at the head of this return during the calendar year 1921. Sworn to and subscribed before me this , day .. 1922. (THIS RXTUXN MUST BE SIGNED AHD SWORM TO) 1420 LU Q Q UJ cc LU cc LU CC UJ Q E UJ cc a. LU CL UJ 1 0. UJ g O Z cc cc cc O UJUJ O zl UJ tn i- o o H * 13 Q. LU o DC O ~ O Q- LU cc Q cc U. o cc LL. o ce u. (S) o LU Q L UJ 7- * > g Ll_ LU UJ LU or LU LU UJ UJ > > LU ESTER, f UJ 2 Z Z n n n Q- O O z o LU C3 Q =) -5 Z . < ir o v LU X O cc UJ cc LU 0. cc UJ Q. u UJ cr * fe 5. LU LU Ul 1- T O LU Q UJ cc tc CC CC u- 0. M COPYR w 0> UJ Q o S CC 2 T Z g 5 2 LU LU U. cc u. u cc u. u cc . z LU z 2 z < E 8 E (0 Z LU CC Q Q < 1 POSITIC UJ O LU Q % Q UJ Q 01 1 1 CM | 1 1 LO II [TOTAL 1 TOTAL 1421 BOOK IV CORPORATE FORMS 7i >iooa >1O ! i'/ ' Part I Forms Relating to Organization CHAPTER I CHARTER FORMS The following charter application, i.e., a complete charter form which upon due allowance by the state officials becomes the actual charter of the company, is that of a corporation organized under the laws of New York.* It is in the ordinary form. It provides for preferred stock and for cumulative voting. Form i. New York Charter CERTIFICATE OF INCORPORATION of the MIDVALE REALTY CORPORATION We, the undersigned, all being of full age and two-thirds being citizens of the United States and one of us a resident of the State of New York, for the purpose of forming a corporation under the Business Corporations Law of the State of New York, do hereby certify and set forth: First The name of said corporation is "MIDVALE REALTY CORPORATION" Second The purposes for which said corporation is to be formed are as follows: (a) To take, lease, purchase or otherwise acquire, and to own, use, hold, sell, convey, exchange, lease, mortgage, work, improve, develop, cultivate, and otherwise handle, deal in, and dispose of real estate, real property, and any interest or right therein. (b) To take, purchase, or otherwise acquire, and to own, hold, sell, convey, exchange, hire, lease, pledge, mortgage, and otherwise deal in and 1 For cost of incorporation, see Book I, Ch. VIII,|"Cost of Incorporation"; for general dis- ion of charters, see Book I, Part V, "The Charter." 1426 CORPORATE FORMS [Bk. IV- dispose of all kinds of personal property, chattels, chattels real, choses in action, notes, bonds, mortgages, and securities. (c) To convert and appropriate any land that may be acquired or be law- fully controlled by this corporation, into and for ways, roads, paths, streets, controlled by this corporation, into and for ways, roads, paths, streets, alleys, sidewalks, parks, gardens, boulevards, and pleasure grounds; and generally to deal with, manage, improve," and administer the lands owned and controlled by the corporation or entrusted to its care. (d) To erect or to have erected, to construct or to have constructed, bouses, works, buildings, storerooms, factories, tenements, edifices and structures of every description; and to rebuild, enlarge, improve, and alter existing houses, works, buildings, storerooms, tenements, edifices, and structures of every description; and to buy, sell, own, use, manage, and lease the same or similar structures. (e) To warrant the title to lands or to any estate or interests in lands sold by said corporation; to issue notes, bonds, and debentures secured by mortgage or deed of trust upon the property of said corporation or other- wise; and to sell and dispose of the same for the benefit of the corporation or for any lawful purpose. (f) To make, enter into, perform, and carry out, contracts for construct- ing, building, altering, improving, repairing, decorating, maintaining, furnishing, and fitting up buildings, tenements, and structures of every description; and to advance money to, and to enter into agreements of all kinds, with builders, contractors, property owners, and others, for said purposes. (g) To collect rents, and to make repairs, and to transact, on commission or otherwise, the general business of a real estate agent, and, generally, the sale, leasing, control and management of lands, buildings, and property of all kinds. (h) To purchase, acquire, hold, and dispose of, stocks, bonds, and other evidences of indebtedness of corporations wheresoever organized, and to pay for the same in cash or in property or by the issuance of its own stock, bonds, or other obligations, to exercise in respect thereto all of the rights, powers, and privileges, of individual owners or holders thereof; and to exercise all voting powers thereon. (i) To purchase or otherwise acquire shares of its own capital stock, and to hold or to dispose of the same or to retire the same, subject, however, to all provisions of the law of the State of New York. (j) To transact any or all of its business outside of the State of New York, and at any place or at one or more places within the United States of America, or the Dominion of Canada, and in any other part of the world, and the corporation shall have all the power to accomplish any and all of its objects and purposes which a natural person would have. Third The amount of capital stock of said corporation is One Million Dol- lars ($1,000,000). The amount of capital with which said corporation will begin business is One Thousand Dollars ($1,000). Fourth The total number of shares which may be issued by the corporation is Ten Thousand (10,000) Shares, of the par value of One Hundred Dollars ($100) each. Of said capital stock Five Thousand (5,000) Shares, of the par value of Five Hundred Thousand Dollars ($500,000) shall be cumulative preferred stock, en- titled to an annual dividend of six per cent (6%) from the profits of the corpora- tion, payable semiannually, on the tenth days of January and July in each year, before any dividends are paid upon the common stock, and to share equally with Ch. i] CHARTER FORMS 1427 the common stock in any excess paid in any year above six per cent (6%) to all the stock, and in the event of liquidation or dissolution from any cause said pre- ferred stock shall be entitled to be paid in full from the assets of the corporation before anything is paid to the common stock. The holders of such preferred stock shall not be entitled to vote in any meeting of the stockholders or election of direc- tors, unless the accumulated dividends due and unpaid such preferred stock at the time shall equal or exceed fifteen per cent (15%) of the par value of said stock. Of said capital stock Five Thousand (5,000) Shares, of the par value of Five Hundred Thousand Dollars ($500,000), shall be common stock of the corporation. Fifth The principal business office of said corporation is to be located in the Borough of Manhattan and in the City, County, and State of New York. Sixth The duration of said corporation is to be perpetual. Seventh The number of directors of said corporation shall be five. Eighth The names and the post-office addresses of the directors of said corporation for the first year are as follows: (Names and addresses of directors omitted.) Ninth The names and the addresses of the subscribers to this certificate, and the number of shares which each agrees to take in said corporation are as follows: NAMES ADDRESSES SHARES John B. Clark 203 Broadway, New York City i Charles F. Holbrook Mount Vernon, N. Y. i Douglas Raymond 212 Madison Ave., New York City i Tenth At all elections of directors of this corporation each stockholder shall be entitled to as many votes as shall equal the number of his shares of stock, multiplied by the number of directors to be elected, and he may cast all of such votes for a single director or may distribute them among the number to be voted for, or any two or more of them, as he may see fit. IN WITNESS WHEREOF, we have made and signed this certificate in duplicate this i3th day of January, one thousand, nine hundred and twenty-two. JOHN B. CLARK CHARLES F. HOLBROOK DOUGLAS RAYMOND STATE OF NEW YORK \ COUNTY OF NEW YORK/ Personally appeared before me this i3th day of January, 1922, John B. Clark, Charles F. Holbrook, and Douglas. Raymond, to me personally known to be the persons described in and who executed the foregoing certificate and severally acknowledged that they executed the same for the purposes therein set forth. HENRY F. SHERWOOD, Notary Public for f NOTARIAL), New York County \ SEAL / 1428 CORPORATE FORMS [Bk. IV- The United States Steel Corporation was first organized with a capital stock of $3,000. This very modest capitalization endured for less than six weeks, when the affairs of the company having reached the proper point for a permanent organization, the capitalization was raised to over one billion dollars at that time the largest industrial capitalization in the world. The charter which follows is the amended charter of the United States Steel Corporation. Form 2. New Jersey Charter AMENDED CERTIFICATE OF INCORPORATION of ; UNITED STATES STEEL CORPORATION We, the undersigned, in order to form a corporation for the purposes herein- after stated, under and pursuant to the provisions of the Act of the Legislature of the State of New Jersey, entitled "An Act Concerning Corporations (Revision of 1896)," and the acts amendatory thereof and supplementary thereto, do hereby certify as follows : I The name of the corporation is "UNITED STATES STEEL CORPORATION" II The location of its principal office in the State of New Jersey is at No. 51 Newark street, in the City of Hoboken, County of Hudson. The name of the agent therein and in charge thereof, upon whom process against the corporation may be served, is Hudson Trust Company. Said office is to be the registered office of said corporation. Ill The objects for which the corporation is formed are: To manufacture iron, steel, manganese, coke, copper, lumber, and other materials, and all or any articles consisting or partly consisting of iron, steel, copper, wood, or other materials, and all or any products thereof. To acquire, own, lease, occupy, use or develop any lands containing coal or iron, manganese, stone or other ores, or oil, and any woodlands, or other lands, for any purpose of .the company. To mine or otherwise to extract or remove coal, ores, stone and other minerals and timber from any lands owned, acquired, leased or occupied by the company, or from any other lands. To buy and sell, or otherwise to deal or to traffic in iron, steel, manganese, copper, stone, ores, coal, coke, wood, lumber and other materials and any of the products thereof, and any articles consisting or partly consisting thereof. To construct bridges, buildings, machinery, ships, boats, engines, cars and other equipment, railroads, docks, slips, elevators, water works, gas Ch. i] CHARTER FORMS 1429 works and electric works, viaducts, aqueducts, canals, and other water- ways, and any other means of transportation, and to sell the same, or otherwise dispose thereof, or to maintain and operate the same, except that the company shall not maintain or operate any railroad or canal in the State of New Jersey. To apply for, obtain, register, purchase, lease or otherwise to acquire, and to hold, use, own, operate and introduce, and to sell, assign, or otherwise to dispose of, any trademarks, trade names, patents, inventions, improve- ments and processes used in connection with or secured under letters patent of the United States, or elsewhere, or otherwise; and to use, exercise, develop, grant licenses in respect of, or otherwise turn to account any such trademarks, patents, licenses, processes and the like, or any property or rights. To engage in any other manufacturing, mining, construction or transpor- tation business of any kind or character whatsoever, and to that end to acquire, hold, own and dispose of any and all property, assets, stocks, bonds and rights of any and every kind, but not to engage in any business hereunder which shall require the exercise of the right of eminent domain within the State of New Jersey. To acquire by purchase, subscription or otherwise, and to hold or to dispose of stocks, bonds, or any other obligations of any corporation formed for, or then or theretofore engaged in or pursuing any one or more of the kinds of business, purposes, objects or operations above indicated, or owning or holding any property of any kind herein mentioned, or of any corporation owning or holding the stocks or the obligations of any such corporation. To hold for investment, or otherwise to use, sell or dispose of, any stock, bonds or other obligations of any such other corporation; to aid in any manner any corporation whose stock, bonds or other obligations are held or are in any manner guaranteed by the company, and to do any other acts or things for the preservation, protection, improvement or enhance- ment of the value of any such stock, bonds or other obligations, or to do any acts or things designed for any such purpose; and, while owner of any such stock, bonds or other obligations, to exercise all the rights, powers and privileges of ownership thereof, and to exercise any and all voting power thereon. The business or purpose of the company is from time to time to do anyone or more of the acts and things herein set forth; and it may conduct its business in other States and in the Territories and in foreign countries, and may have one office or more than one office, and keep the books of the company outside of the State of New Jersey, except as otherwise may be provided by law; and may hold, purchase, mortgage and convey real and personal property either in or out of the State of New Jersey. Without in any particular limiting any of the objects and powers of the corporation, it is hereby expressly declared and provided that the cor- poration shall have power to issue bonds and other obligations in payment for property purchased or acquired by it, or for any other object in or about its business; to mortgage or pledge any stock, bonds or other obligations, or any property which may be acquired by it, to secure any bonds or other obligations by it issued or incurred; to guarantee any dividends or bonds or contracts or other obligations; to make and per- form contracts of any kind and description; and in carrying on its busi- ness, or for the purpose of attaining or furthering any of its objects, to do any and all other acts and things, and to exercise any and all other powers which a copartnership or natural person could do and exercise, and which now or hereafter may be authorized by law. IV The total authorized capital stock of the corporation is eleven hundred 1430 CORPORATE FORMS [Bk. IV- million dollars ($1,100,000,000), divided into eleven million shares of the par value of one hundred dollars each. Of such total authorized capital stock five million live hundred thousand shares, amounting to five hundred and fifty million dollars, shall be preferred stock, and five million five hundred thousand shares, amounting to five hundred and fifty million dollars, shall be common stock. From time to time the preferred stock and the common stock may be increased according to law, and may be issued in such amounts and proportions as shall be determined by the Board of Directors and as may be permitted by law. The holders of the preferred stock shall be entitled to receive, when and as declared, from the surplus or net profits of the corporation, yearly dividends at the rate of seven per centum per annum and no more, payable quarterly on dates to be fixed by the by-laws. The dividends on the preferred stock shall be cumu- lative, and shall be payable before any dividends on the common stock shall be paid or set apart; so that, if in any year dividends amounting to seven per cent shall not have been paid thereon, the deficiency shall be payable before any divi- dends shall be paid upon or set apart for the common stock. Whenever all cumulative dividends on the preferred stock for all previous years shall have been declared and shall have become payable, and the accrued quarterly installments for the current year shall have been declared, and the company shall have paid such cumulative dividends for previous years and such accrued quarterly installments, or shall have set aside from its surplus or net profits a sum sufficient for the payment thereof, the Board of Directors may declare dividends on the common stock, payable then or thereafter, out of any remaining surplus or net profits. In the event of any liquidation or dissolution or winding up (whether volun- tary or involuntary) of the corporation, the holders of the preferred stock shall be entitled to be paid in full both the par amount of their shares and the unpaid divi- dends accrued thereon before any amount shall be paid to the holders of the common stock and, after the payment to the holders of the preferred stock of its par value and the unpaid accrued dividends thereon, the remaining assets and funds shall be divided and paid to the holders of the common stock according to their respective shares. V The names and post-office addresses of the incorporates, and the number of shares of stock for which severally and respectively we do hereby subscribe (the aggregate of our said subscriptions, being three thousand dollars, is the amount of capital stock with which the corporation will commence business), are as follows: NUMBER OF SHARES PREFERRED COMMON NAME POST-OFFICE ADDRESS STOCK STOCK Charles C. Cluff 51 Newark St., Hoboken, N J. 5 5 William J. Curtis 51 Newark St., Hoboken, N. J. 5 5 Charles MacVeagh 51 Newark St., Hoboken, N. J. 5 5 VI The duration of the corporation shall be perpetual. VII The number of Directors of the company shall be fixed from time to time by the by-laws; but the number, if fixed at more than three, shall be some multiple of three. The Directors shall be classified with respect to the time for which they shall severally hold office by dividing them into three classes, each consisting of one-third of the whole number of the Board of Directors. The Directors of the first class shall be elected for a term of one year; the Directors of the second class for a term of two years, and the Directors of the third class for a term of three years; and at each annual election the successors of the class of Directors whose terms shall expire in that year shall be elected to hold office for the term of three years, so that the term of office of one class of Directors shall expire in each year. Ch. i] CHARTER FORMS * 1431 The number of Directors may be increased as may be provided in the by-laws. In case of any increase of the number of the Directors the additional Directors shall be elected as may be provided in the by-laws, by the Directors or by the stockholders at an annual or special meeting; and one-third of their number shall be elected for the then unexpired portion of the term of the Directors of the first class, one-third of their number for the unexpired portion of the term of the Direc- tors of the second class, and one-third of their number for the unexpired portion of the term of Directors of the third class, so that each class of Directors shall be increased equally In case of any vacancy in any class of Directors through death, resignation, disqualification or other cause, the remaining Directors, by affirmative vote of a majority of the Board of Directors, may elect a successor to hold office for the unex- pired portion of the term of the Director whose place shall be vacant, and until the election of a successor. The Board of Directors shall have power to hold their meetings outside of the State of New Jersey, at such places as from time to time may be designated by the by-laws or by resolution of the Board. The by-laws may prescribe the number of Directors necessary to constitute a quorum of the Board of Directors, which number may be less than a majority of the whole number of the Directors. Unless authorized by votes given in person or by proxy by stockholders holding at least two-thirds of the capital stock of the corporation, which is represented and voted upon in person or by proxy at a meeting specially called for that purpose or at an annual meeting, the Board of Directors shall not mortgage or pledge any of its real property, or any shares of the capital stock of any other corporation; but this prohibition shall not be construed to apply to the execution of any purchase- money mortgage or any other purchase-money lien. As authorized by the Act of the Legislature of the State of New Jersey, passed March 22, 1901, amending the i7th section of the Act Concerning Corporations (Revision of 1896), any action which theretofore required the consent of the holders of two-thirds of the stock at any meeting after notice to them given, or required their consent in writing to be filed, may be taken upon the consent of, and the consent given and filed by the holders of two-thirds of the stock of each class represented at such meeting in person or by proxy. Any officers elected or appointed by the Board of Directors may be removed at any time by the affirmative vote of a majority of the whole Board of Directors. Any other officer or employee of the company may be removed at any time by vote of the Board of Directors, or by any committee or superior officer upon whom such power of removal may be conferred by the by-laws or by vote of the Board of Directors. The Board of Directors, by the affirmative vote of a majority of the whole Board, may appoint from the Directors an executive committee, of which a ma- jority shall constitute a quorum; and to such extent as shall be provided in the by-laws, such committee shall have and may exercise all or any of the powers of the Board of Directors, including power to cause the seal of the corporation to be affixed to all papers that may require it. The Board of Directors, by the affirmative vote of a majority of the whole Board, may appoint any other standing committees, and such standing committees shall have and may exercise such powers as shall be conferred or authorized by the by-laws. The Board of Directors may appoint not only other officers of the com- pany, but also one or more Vice-Presidents, one or more Assistant Treasurers, and one or more Assistant Secretaries; and to the extent provided in the by-laws the persons so appointed respectively shall have and may exercise all the powers of the President, of the Treasurer and of the Secretary, respectively. The Board of Directors shall have power from time to time to fix and to determine and to vary the amount of the working capital of the company; and to ' CORPORATE FORMS [Bk. IV- direct and determine the use and disposition of any surplus or net profits over and above the capital stock paid in; and in its discretion the Board of Directors may use and apply any such surplus or accumulated profits in purchasing or acquiring its bonds or other obligations, or shares of its own capital stock, to such extent and in such manner and upon such terms as the Board of Directors shall deem ex- pedient; but shares of such capital stock so purchased or acquired may be resold, unless such shares shall have been retired for the purpose of decreasing the company's capital stock, as provided by law. The Board of Directors from time to time shall determine whether and to what extent, and at what times and places, and under what conditions and regula- tions, the accounts and books of the Corporation, or any of them, shall be open to the inspection of the stockholders, and no stockholder shall have any right to inspect any account or book or document of the Corporation, except as conferred by statute or authorized by the Board of Directors, or by resolution of the stock- holders. Subject always to by-laws made by the stockholders, the Board of Directors may make by-laws, and from time to tune may alter, amend or repeal any by-laws, but any by-laws made by the Board of Directors may be altered or repealed by the stockholders at any annual meeting, or at any special meeting, provided notice of such proposed alteration or repeal be included in the notice of the meeting. IN WITNESS WHEREOF, we have hereunto set our hands and seals the 23rd day of February, 1901. CHARLES C. CLUFF [L. s.] WILLIAM J. CURTIS [L. s.j CHARLES MACVEAGH [L. s.j Signed, sealed and delivered in the presence of FRANCIS LYNDE STETSON VICTOR MORAWETZ STATE OF NEW JERSEY! . COUNTY OF HUDSON / Be It Remembered, that on this 23rd day of February, 1901, before the undersigned, personally appeared Charles C. Cluff, William J. Curtis, and Charles MacVeagh, who, I am satisfied, are the persons named in and who executed the foregoing certificate; and I having first made known to them, and to each of them, the contents thereof, they did each acknowledge that they signed, sealed and delivered the same as their voluntary act and deed. GEO. HOLMES, Master in Chancery of New Jersey The following charter form is that of a corporation to be organized under the laws of Delaware, but intending to carry on its business and to have its offices and plant elsewhere. It is incorporated in Delaware to escape the high cost of incorporation in the state in which it expects to conduct its business. Some- times such outside organization is resorted to in order to secure powers not obtainable in the state of operation. Ch. i] CHARTER FORMS 1433 Form 3. Delaware Charter CERTIFICATE OF INCORPORATION of the HOLLIS BAKERY First The name of this corporation is "HOLLIS BAKERY" Second The location of its principal office in the State of Delaware is to be in the City of Wilmington, County of New Castle. The agent in charge thereof is James L. MacPherson. Third The objects and purposes for which this corporation is formed are to do any and all of the things herein set forth, as fully and to the same extent as natural persons might or could do, and in any part of the world, viz. : (a) To manufacture, buy, sell, pack, prepare, and generally to deal in and with breads, biscuits, crackers, cakes, Italian paste, confectionery, cereals, coffees, teas, dried fruits, and foods and food products, and ma- terials of all kinds, either raw or manufactured, that may be used in foods and food products, or for the packing, adapting, preparing, or preserving of such foods, or food products; and generally to mix, adapt, refine, pre- pare, preserve, manufacture, and dispose of all such goods, wares, mer- chandise, and materials, either in original packages or in such cans, jars, boxes, cartons, or other containing packages as may be found necessary or desirable. (b) To purchase, lease, or otherwise acquire lands, buildings, tenements, and factories, in Delaware or elsewhere, for the plants, offices, workshops, warehouses, laboratories, and manufactories of the Company, and to pur- chase, lease, or otherwise acquire tools, implements, engines, machinery, apparatus, fixtures, and conveniences of all kinds, for the manufacture, manipulation, preparation, preservation, packing, and handling of the ma- terials and products of the Company. (c) To apply for, obtain, purchase, lease, or otherwise acquire, and to register, hold, own, and use any and all trade-marks, trade secrets, processes, formulae, inventions, and improvements capable of being used in con- nection with the work of the Company, whether secured under letters pa'tent in the United States or elsewhere or otherwise; and to use, operate, and manufacture under the same, and to sell, assign, grant licenses in respect of or otherwise dispose of and turn the same to the account and profit of the Company. (d) To do any and all things set forth in this certificate as objects, pur- poses, powers, or otherwise to the same extent and as fully as natural persons might do, and in any part of the world, as principals, agents, contractors, trustees, or otherwise, and either alone or in company with others. (e) To have offices, conduct its business, and promote its objects within and without the State of Delaware, in other States, the District of Columbia, the territories and colonial dependencies of the United States, and in foreign countries, without restriction as to place or amount. Fourth The amount of the total authorized capital stock of this corporation is Five Hundred Thousand Dollars ($500,000), divided into Five Thousand (5,00 ) Shares of the par value of One Hundred Dollars ($100) each. 1434 CORPORATE FORMS (Bk. IV- The amount of capital stock with which this corporation will commence business is the sum of One Thousand Dollars ($1,000). Fifth The names and places of residence of each of the original subscribers to the capital stock, and the number of shares subscribed for by each, are as follows: NO. OF NAMES RESIDENCES SHARES HENRY A. HOLLIS Cincinnati, Ohio 3 JOHN H. MASON 3 FRANK MENCKEN 4 Sixth The existence of this corporation is to be perpetual. Seventh The private property of the stockholders shall not be subject to the payment of corporate debts to any extent whatever. Eighth In furtherance, and not in limitation of the powers conferred by statute, the Board of Directors are expressly authorized: To make, alter, amend, and repeal the by-laws; to fix the amount to be reserved for working capital, and to authorize and cause to be executed mortgages and liens, without limit as to amount, upon the property and franchises of this corporation. With the consent in writing, and pursuant to a vote of the holders of a majority of the capital stock issued and outstanding, to dispose in any manner of the whole property of this corporation. To determine from tune to time whether and to what extent the accounts and books of this corporation, or any of them, shall be open to the inspection of the stockholders; and no stockholder shall have any right of inspecting any account, or book, or document of this corporation, except as conferred by law, or the by-laws, or by resolution of the stockholders. The stockholders and directors shall have power to hold their meetings and keep the books, documents, and papers of the corporation outside of the State of Delaware, at such places as may be from time to time designated by the by-laws or by resolution of the stockholders or directors, except as otherwise required by the laws of Delaware. It is the intention that the objects, purposes, and powers specified in the third paragraph hereof shall, except where otherwise specified in said paragraph, be nowise limited or restricted by reference to or inference from the terms of any other clause or paragraph in this certificate of incorporation, but that the objects, purposes, and powers specified in the third paragraph and in each of the clauses or paragraphs of this charter shall be regarded as independent objects, purposes, and powers. We, the undersigned, being all the original subscribers to the capital stock hereinbefore named, for the purpose of forming a corporation under the laws of the State of Delaware, do make, file, and record this certificate, and do hereby certify that the facts herein stated are true; and we have accordingly hereunto set our respective hands and seals, this sixteenth day of January, A. D. 1922. HENRY A. HOLLIS [SEAL] JOHN H. MASON [SEAL] FRANK MENCKEN [SEAL] In presence of JAMES BEHRENS SAMUEL S. MILLER Ch. i] CHARTER FORMS 1435 STATE OF DELAWARE \ . COUNTY OF NEW CASTLE) Be It Remembered, that on this sixteenth day of January, A. D. 1922, person- ally came before me, Howard Franklin, a Notary Public in and for the county and state aforesaid, Henry A. Hollis, John H. Mason, and Frank Mencken, parties to the foregoing certificate of incorporation, known to me personally to be such, and severally acknowledged the said certificate to be the act and deed of the signers respectively, and that the facts therein stated are truly set forth. Given under my hand and seal of office the day and year aforesaid. HOWARD FRANKLIN, Notary Public ("NOTARIAL \ \ SEAL / The following charter of the General Motors Corporation is unusual in its very brief, direct purposes and its extended state- ment of connected, collateral, or general purposes. Form 4. Delaware Charter No-Par-Value Shares GENERAL MOTORS CORPORATION CERTIFICATE OF INCORPORATION WE, the undersigned, in order to form a corporation for the purposes herein- after stated, under and pursuant to the provisions of an Act of the Legislature of the State of Delaware, entitled "An Act Providing a General Corporation Law" (approved March 10, 1899), and- the acts amendatory thereof and supplemental thereto, do hereby certify as follows: FIRST: The name of the corporation is GENERAL MOTORS CORPORATION SECOND: The principal office of the corporation is to be* located at No. 7 West Tenth Street, in the City of Wilmington, County of New Castle, State of Delaware. The name of its resident agent in charge thereof is the Corporation Trust Company of America, whose address is No. 7 West Tenth Street, in the City of Wilmington, County of New Castle, State of Delaware. THIRD: The nature of the business of the corporation and the objects and purposes proposed to be transacted, promoted, or carried on by it, are as follows, to-wit: (a) To manufacture, buy, sell and deal in automobiles, trucks, cars, boats, flying machines and other vehicles, their parts and accessories, and kindred articles, and generally to conduct an automobile business in all its branches. (b) To purchase or otherwise acquire, lease, assign, mortgage, pledge or other- wise dispose of any trade names, trade marks, concessions, inventions, formulae, improvements, processes of any nature whatsoever, copyrights, and letters patent of the United States and of foreign countries, and to accept and grant licenses thereunder. 1436 CORPORATE FORMS [Bk. IV- (c) To subscribe or cause to be subscribed for, and to purchase or otherwise acquire, hold for investment, sell, assign, transfer, mortgage, pledge, exchange, distribute or otherwise dispose of the whole or any part of the shares of the capital stock, bonds, coupons, mortgages, deeds of trust, debentures, securities, obligations, notes and other evidences of indebtedness of any corporation, stock company or association, now or hereafter existing, and whether created by or under the laws of the State of Delaware, or otherwise; and while owners of any of said shares of capital stock or bonds or other property to exercise all the rights, powers and privileges of ownership of every kind and description, including the right to vote thereon, with power to designate some person for that purpose from time to time to the same extent as natural persons might or could do. (d) To purchase, hold, sell and reissue the shares of its own capital stock. (e) To buy, lease, or otherwise acquire, so far as may be permitted by law, the whole or any part of the business, good-will, and assets of any person, firm, association or corporation (either foreign or domestic) engaged in a business of the same general character as that for which this corporation is organized. (f) To endorse, guarantee and secure the payment and satisfaction of bonds, coupons, mortgages, deeds of trust, debentures, securities, obligations and evi- dences of indebtedness, and also to guarantee and secure the payment or satis- faction of interest on obligations and of dividends on shares of the capital stock of other corporations; also to assume the whole or any part of the liabilities, existing or prospective, of any person, corporation, firm or association; and to aid in any manner aay other person or corporation with which it has business dealings, or whose stocks, bonds, or other obligations are held or are in any manner guaranteed by the corporation, and to do any other acts and things for the preservation, pro- tection, improvement, or enhancement of the value of such stocks, bonds, or other obligations. (g) To engage in any other manufacturing or mercantile business of any kind or character whatsoever, and to that end to acquire, hold, own and dispose of any and all property, assets, stocks, bonds and rights of any and every kind. (h) Without in any particular limiting any of the objects' and powers of the corporation, it is hereby expressly declared and provided that the corporation shall have power to do all things hereinbefore enumerated, and also to issue or exchange stocks, bonds and other obligations in payment for property purchased or acquired by it, or for any other object in or about its business; to borrow money without limit; to mortgage or pledge its franchises, real or personal property, income and profits accruing to it, any stocks, bonds or other obligations, or any property which may be acquired by it, and to secure any bonds or other obligations by it issued or incurred. (i) To carry on any business whatsoever which the corporation may deem proper or convenient in connection with any of the foregoing purposes or otherwise, or which may be calculated, directly or indirectly, to promote the interests of the corporation or to enhance the value of its property; to conduct its business in this State, in other States, in the District of Columbia, in the Territories and Colonies of the United States, and in foreign countries; and to hold, purchase, mortgage and convey real and personal property, either in or out of the State of Delaware, and to have and to exercise all the powers conferred by the laws of Delaware upon corporations formed under the act pursuant to and under which this corporation is formed. FOURTH: The total authorized capital stock of the Corporation is as follows: The number of shares of stock that may be issued shall be Fifty Six Million One Hundred Thousand (56,100,000) shares, of which Two Hundred Thousand (200,000) shares shall be preferred stock, having a par value of One Hundred Dollars ($100) each, Nine Hundred Thousand (900,000) shares shall be debenture stock, having z. par value of One Hundred Dollars ($100) each, Five Million (5,000,- Ch. i] CHARTER FORMS 1437 ooo) shares shall be seven per cent. (7%) debenture stock, having a par value of One Hundred Dollars ($100) each, and Fifty Million (50,000,000) shares shall be_common stock, without any nominal or par value. From time to time the seven per cent. (7%) debenture stock, the debenture stock, the preferred stock and the common stock may be increased or decreased according to law, and may be issued in such amounts and proportions as shall be determined by the Board of Directors and as may be permitted by law, except that no seven per cent. (7%) debenture stock or debenture stock shall be issued unless the net assets of the corporation above all direct liabilities, as shown by the books of the corporation, except capital stock liability, shall amount, after the issue of said seven per cent. (7%) debenture stock and debenture stock, to at least one and one-half times the par value of all seven per cent. (7%) debenture stock and de- benture stock issued and outstanding. The holders of the seven per cent. (7%) debenture stock, the debenture stock, and the preferred stock shall be entitled pari passu to receive, when and as declared, from the surplus or net profits of the corporation, yearly dividends at the rate of six per centum (6%) per annum on the debenture stock and preferred stock, and seven per centum (7%) per annum on the seven per cent. (7%) debenture stock, and no more, payable quarterly on dates to be fixed by the By-Laws, which divi- dends shall run from the date of the issue of said preferred stock, said seven per cent. (7%) debenture stock and said debenture stock. The dividends on the preferred stock, the seven per cent. (7%) debenture stock and the debenture stock shall be cumulative and shall be payable before any dividend on the common stock shall be paid or set apart, so that, if in any year, dividends amounting to six per centum (6%) on the preferred stock and on the debenture stock, and amounting to seven per centum (7%) on the seven per cent. (7%) debenture stock shall not have been paid thereon, the deficiency shall be payable before any dividend shall be paid upon, or set apart for the common stock. Whenever all cumulative dividends on the preferred stock, the seven per cent. (?%) debenture stock and the debenture stock shall have been paid, and a sum sufficient for the payment of the next ensuing quarterly dividend on the preferred stock, the seven per cent. (7%) debenture stock and the debenture stock shall have been set aside from the surplus or the net profits, the Board of Directors may declare dividends on the common stock, payable then or thereafter, out of any remaining surplus or net profits. In the event of any liquidation or dissolution, or winding-up, whether voluntary or otherwise, of the corporation, the holders of the preferred stock, the seven per cent. (7%) debenture stock, and the debenture stock, before any amount shall be paid to the holders of the common stock, shall be entitled to be paid pari passu in full, both the par amount of their shares and the unpaid dividends accrued thereon; and after such payment is made, the remaining assets and funds shall be divided among and paid to the holders of the common stock pro rata according to their respective shares. The preferred stock at the option of the Board of Directors shall be subject to redemption in whole or in part at One Hundred Ten Dojlars ($110) per share and accrued dividends thereon, on the first day of November, 1918, or on any subsequent dividend-paying date in such manner as the Board of Directors may determine. The debenture stock, at the option of the Board of Directors, shall be subject to redemption in whole or in part at One Hundred Fifteen Dollars ($115) per share and accrued dividends thereon, on the first day of November, 1919, or on any subsequent dividend-paying date in such manner as the Board of Directors may determine. The seven per cent. (7%) debenture stock, at the option of the Board of Directors, shall be subject to redemption in whole or in part at One Hundred Twenty Dollars ($120) per share and accrued dividends thereon, on the first day of November, 1920, or on any subsequent dividend-paying date in such manner as the Board of Directors may determine. 1438 CORPORATE FORMS [Bk. IV- The holders of the preferred stock, the seven per cent. (7%) debenture stock and the debenture stock shall not have any voting power whatsoever, except upon the question of selling, conveying, transferring or otherwise disposing of the prop- erty and assets of the corporation as an entirety, provided, however: (a) In the event that the corporation shall fail to pay any dividend upon the preferred stock when it regularly becomes due, and such dividend shall remain in arrears for a period of six (6) months, the holders of the preferred stock shall have the right to vote onfall matters in like manner as the holders of the common stock, during the year next ensuing, and during each year thereafter during the continu- ance of said default until the corporation shall have paid all accrued dividends upon the preferred stock; (b) In the event that the corporation shall fail to pay any dividend on the seven per cent. (7%) debenture stock or on the debenture stock when it regularly becomes due, and such default shall continue for a period of six (6) months, the holders of the seven per cent. (7%) debenture stock and of the debenture stock shall have the sole and exclusive right of voting on all questions whatsoever, to the exclusion of the holders of the common and preferred stock, during the continuance of such default until the corporation shall have paid all accrued divi- dends on the debenture stock and on the seven per cent (7%) debenture stock; or (c) In the event that the earnings of the corporation during any calendar year shall amount to less than nine per cent. (9%) on the par value of the seven per cent (?%) debenture stock and the debenture stock issued and outstanding during said year, the holder of each share of the seven per cent. (7%) debenture stock and the debenture -stock shall have an equal right to vote on all questions with the holder of each share of the common stock, which right to vote shall continue during the continuance of said default until such time as the net earnings during some future calendar year shall equal nine per cent. (9%) on the par value of the seven per cent. (?%) debenture stock and the debenture stock issued and outstanding in such year. The holders of the common stock shall have the right to vote on all questions to the exclusion of all other stockholders, except as herein otherwise provided. x Any preferred stock, seven per cent. (7%) debenture stock, debenture stock, or common stock, authorized hereunder or under any amendment hereof, in the discretion of the Board of Directors may be issued except as herein otherwise pro- vided in payment for property or services, or as bonuses to employees of the corpora- tion or employes of subsidiary companies, or for other assets or securities, including cash, necessary or desirable to be purchased or acquired from time to time for the corporation, or as a dividend upon the common stock payable in preferred seven per cent. (7%) debenture, or common stock of the corporation. No holders of stock of the corporation of whatever class shall have any preferential right of subscription to any shares of any class of stock of the corpora- tion issued or sold, or to be issued or sold, or to any obligations convertible into stock of the corporation, nor any right of subscription to any thereof, other than such, if any, as the Board of Directors in its discretion, may determine, and any shares or convertible obligations which the Board of Directors may determine to offer for subscription to the holders of stock may, in its discretion, be offered to the holders of preferred stock and/or seven per cent. (7%) debenture stock, and /or debenture stock, and/ or common stock, to the exclusion of any other class or classes of stock then existing, provided however, that no additional common stock or obligations convertible into common stock shall be issued or sold for cash, except after first having been offered for subscription to the holders of the then outstanding common stock according to their respective shares. Unless the holders of at least three-fourths in amount of the seven per cent. (7%) debenture stock and debenture stock then outstanding shall consent thereto either in writing or at a special meeting, the Board of Directors shall not mortgage or pledge or place any specific lien upon the whole or any part of the property of the corporation, but this prohibition shall not be construed to apply to the execution Ch. i] CHARTER FORMS 1439 of any purchase money mortgage or any other purchase money lien, nor to the assumption of any mortgage or other lien upon property purchased nor to the renewal or renewals thereof or to substitutions therefor, in whole or in part, nor shall it prevent the directors at any time from pledging securities belonging to the corporation for the purpose of securing cash to be used in the ordinary course of the business of the corporation, provided such cash advances are procured upon obligations of the corporation which shall mature not more than three years from the date thereof; nor shall any amendment to any provision contained in this certificate of incorporation in reference to the rights and the security of the holders of the seven per cent. (7%) debenture stock and/or the debenture stock be au- thorized, unless such amendment is consented to by the holders of three-fourths of the seven per cent. (7%) debenture stock and/or the debenture stock then issued and outstanding. The preferred stock and the debenture stock may be exchanged in the manner and at the times prescribed by the Board of Directors, on the basis of one share of preferred or debenture stock and One Hundred Dollars ($100) cash for two (2) shares of seven per cent. (7%) debenture stock. The common stock may be issued by the Corporation from time to time for such consideration, not less than Ten Dollars ($10) a share, paid for wholly or partly by cash, by labor done, by personal property or by real property or leases thereof, or as dividends from the surplus or net profits at such price, as may be fixed from time to time by the Board of Directors. Each share of the common capital stock of the Corporation now outstanding, of the par value of One Hundred Dollars ($100) each, shall be exchanged for ten (10) shares of common stock of no par value, in such manner as may be prescribed by the Board of Directors. The amount of capital stock with which the Corporation will commence business is the sum of One Thousand Five Hundred Dollars ($1,500) being fifteen shares of the common capital stock of the Corporation of the par value of One Hundred Dollars ($100) each. FIFTH: The names and places of residence of each of the original subscribers to the capital stock and the number of shares subscribed for by each are as follows: NUMBER OF NAME RESIDENCE SHARES COMMON STOCK HERBERT E. LATTER Wilmington, Delaware 5 NORMAN P. COFFIN Wilmington, Delaware 5 CLEMENT M. EGNER Elkton, Maryland 5 SIXTH: The corporation is to have perpetual existence. SEVENTH: The private property of the stockholders shall not be subject to the payment of corporate debts to any extent whatever. EIGHTH: The number of Directors of the corporation, not less than three, shall be fixed from time to time by the By-laws and the number may be altered as therein provided. In case of any increase in the number of Directors, the additional Directors shall be elected as provided by the By-laws, by the Directors, or by the stockholders at an annual or special meeting. In case of any vacancy in the Board of Directors, the remaining Directors, by affirmative vote of a majority thereof, may elect a successor to hold office for the unexpired portion of the term of the Director whose place is vacant and until his successor shall be duly elected and qualified. In furtherance, and not in limitation of the powers conferred by law, the Board of Directors are expressly authorized: (a) To make, alter, amend and repeal the By-laws of the corporation. 1440 CORPORATE FORMS |Bk. IV- (b) To remove at any time any officer elected or appointed by the Board of Directors but only by the affirmative vote of a majority of the whole Board of Directors. Any other officer or employe of the corporation may be removed at any time by a vote of the Board of Directors, or by any committee or superior officer upon whom such power of removal may be conferred by the By-laws or by the vote of the Board of Directors, (c) To designate, by resolution passed by a majority of the whole Board, two or more of their number to constitute an executive committee, who, to the extent provided in said resolution or in the By-laws of the corporation, shall have and exercise the powers of the Board of Directors in the management of the business and affairs of the corporation, and shall have power to authorize the seal of the cor- poration to be affixed to all papers which may require it. A majority of such committee shall constitute a quorum for the transaction of business. To designate any other standing committees by the affirmative vote of a ma- jority of the whole Board, and such standing committees shall have and may exercise such powers as shall be conferred or authorized by the By-laws, including the power to cause the seal of the corporation to be affixed to any papers which may require it. (d) From time to time to fix and to vary the sum to be reserved over and above its capital stock paid in before declaring any dividends; to direct and deter- mine the use and disposition of any surplus or net profits over and above thecapital stock paid in; to fix the time of declaring and paying any dividend, and, unless otherwise provided in this Certificate or in the By-laws, to determine the amount of any dividend. All sums reserved as working capital or otherwise may be applied from time to time to the acquisition or purchase of its bonds or other obligations or shares of its own capital stock or other property to such extent and in such man- ner and upon such terms as the Board of Directors shall deem expedient and neither the stocks, bonds or other property so acquired shall be regarded as ac- cumulated profits for the purpose of declaring or paying dividends unless otherwise determined by the Board of Directors, but shares of such capital stock so purchased or acquired may be resold, unless such shares shall have been retired for the pur- pose of decreasing the Company's capital stock as provided by law. (e) From time to time to determine whether and to what extent, and at what time and places and under what conditions and regulations the accounts and books of the corporation (other than the stock ledger), or any of them, shall be open to the inspection of the stockholders; and no stockholder shall have any right to inspect any account or book or document of the corporation, except as conferred by statute or authorized by the Board of Directors or by a resolution of the stock- holders. (f) With the written assent of the holders of two-thirds of its issued and out- standing stock of all classes, without a meeting, or pursuant to the affirmative vote in person or by proxy of the holders of two-thirds of its issued and outstanding stock of all classes, at any meeting, either annual or special, called as provided in the By-laws, the Board of Directors may sell, convey, assign, transfer or otherwise dispose of, any part or all of the property, assets, rights and privileges of the cor- poration as an entirety, for the stock, bonds, obligations or other securities of another corporation of this or of any other State, Territory, Colony or foreign country, or for cash, or partly cash, credit, or property, or for such other considera- tion as the Board of Directors, in their absolute and uncontrolled discretion, may determine. (g) The corporation may by its By-laws confer upon the Directors powers and authorities additional to the foregoing and to those expressly conferred upon them by statute. NINTH: Both the stockholders and the Directors of the corporation may hold their meetings and the corporation may have an office or offices in such place or places outside of the State of Delaware as the By-laws may provide, and the cor- Ch. i] CHARTER FORMS 1441 poration may keep its books outside of the State of Delaware except as otherwise provided by law. TENTH: The corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation in the manner, now or hereafter prescribed by statute, and all rights conferred on stockholders herein are granted subject to this reservation. IN WITNESS WHEREOF we have hereunto set our hands and seals this i3th day of October 1916 HERBERT E. LATTER [SEAL] NORMAN P. COFFIN [SEAL] CLEMENT M. EGNER [SEAL] In the presence of: WILLIAM J. MALONEY , STATE OF DELAWARE \ County of New Castle/ BE IT REMEMBERED that on this i3th day of October, A. D. 1916, personally came before me William J. Maloney, a Notary Public in and for the County and State aforesaid, Herbert E. Latter, Norman P. Coffin and Clement M. Egner, parties to the foregoing Certificate of Incorporation, known to me personally to be such and simultaneously acknowledged the said certificate to be the act and deed of the signers respectively and that the facts therein stated are truly set forth. Given under my hand and seal of office the day and year aforesaid. WILLIAM J. MALONEY, Notary Public I'SEAL] CHAPTER II SPECIAL CHARTER CLAUSES The lines of business directly covered by the special charter clauses of the present chapter are representative. Where any desired business is not included, it will in most cases be possible to find among those given, some related, or similar purpose clauses that can be adapted to meet the particular requirements. The clauses of Forms 5 to 53 cover the specific purposes of particular businesses. It is usual, as will be seen by reference to the charters of the preceding chapter, to include in the charter of the ordinary business corporation other clauses giving general powers in addition to the specific purposes. Such clauses will be found in Forms 54 to 64. As a corporation always has power to do such legitimate things as are necessary to effect the pur- poses of its creation, these additional clauses are not as a rule strictly necessary, but are added for the sake of completeness and to remove any possible doubt as to the extent of the cor- porate powers. The direct purpose clauses, Forms 5 to 53, are arranged alpha- betically. Form 5. Advertising To carry on the general business of advertising and to act as advertising agents: (a) To undertake and carry into effect contracts with individuals, firms, and corporations for advertising and publicity in all its varieties. (b) To deal and contract for advertisements and advertising in papers, periodi- cals and by mail, signs, bill-boards, and posters in all forms and in all places. (c) To print, publish, and circulate all forms of advertising and publicity material. (d) To print, publish, and deal in all kinds of papers, publications, and articles or things useful to or in connection with advertising and publicity. Ch. 2! SPECIAL CHARTER CLAUSES 1443 Form 6. Amusement Devices (a) To make, install, and operate certain devices, mechanisms, and apparatus for amusement, recreation, entertainment, and exhibition, invented or devised by Ward L. Donaldson. (b) To make, lease, purchase, and otherwise acquire, and to use, operate, sell, and license to use, all manner of devices, apparatus, and constructions for the purpose of amusement, recreation, entertainment, and exhibition. (c) To purchase, lease, exchange, and otherwise acquire any and all rights, permits, privileges, franchises, and concessions suitable or convenient for the purposes of the Company. Form 7. Automobiles To assemble, manufacture, sell, and deal in, and to import and export, motor cars, automobiles, and motor vehicles of all kinds and descriptions whatsoever, and to carry on any trade or business incidental thereto or connected therewith. To manufacture, buy, sell, and deal in all kinds of motors, engines.'mechanisms, and devices operated by steam, electricity, internal combustion, and other forces or applications of power. Form 8. Automobiles and Garage To manufacture, deal in, sell, operate, and let for hire automobiles, motor cycles, and motor vehicles and supplies and fittings therefor of every kind, nature, and description. To erect, lease, or otherwise acquire, and to maintain and operate, a garage or garages for the storing, caring for, and repairing of automobiles and motor vehicles of every kind, nature, and description. To make and sell parts, supplies, batteries, and accessories useful with and in connection with the use of motor cars and vehicles; to store, clean, and repair automobiles and motor vehicles, and to replace their parts, and to do all other things incidental to the business of conducting a garage and repair shop, or profit- able in connection therewith. Form 9. Bonds and Securities (a) To buy, sell, exchange, pledge, mortgage, and generally deal in and with government, municipal, and industrial bonds, stocks, and other securities, and in and with bonds and mortgages or other evidences of indebtedness or ownership of any individual, firm, or corporation, and in and with stocks, debentures, trust receipts, and other securities of corporations, both domestic and foreign; and while the owner thereof to exercise the rights and privileges of ownership, including the right to vote thereon, and to issue in exchange therefor its own stock, bonds, and other obligations, and generally to carry on the business of stock and bond brokers; but nothing herein shall be construed as an attempt to secure powers not properly obtainable by corporations organized under the Business Corporation Law of the State of New York. 1444 CORPORATE FORMS [Bk. IV- (b) To deposit in trust with any person, firm, or corporation or corporations, any or all of said bonds, stocks, or other securities, and issue against such securities collateral trust gold notes in any denomination that may be deemed desirable by the directors of the company. (c) To buy, sell, rent, lease, or otherwise acquire, to hold, own, use, improve, mortgage, sell, exchange, lease, or otherwise dispose of real property, improved or unimproved. (d) To register and certify, or to guarantee, the genuineness or authenticity of, or the payment of the principal or interest of any bonds, notes or debentures of any person, firm, corporation, or association so far as the same may be permitted by corporations organized under the act under which this company is incorporated. (e) To borrow money with or without pledge of or mortgage on all or any of its property, real or personal, as security, and to loan and advance money upon mortgages on personal and real property or on either of them. (See also Form 51) Form 10. Brick Machinery (a) To secure for the State of New York rights to manufacture, use, operate ; sell, lease, and otherwise dispose of the brick-pressing mechanism and machinery invented and patented by James D. Warner. (b) To make, manufacture, buy, sell, and generally to deal in and with brick, tile, and all other sand, lime, clay, cement, earthen, mineral, and composition wares, materials, and manufactures. (c) To purchase, lease, or otherwise acquire lands, kilns, depots, buildings, warehouses, factories, rights, inventions, machinery, and plants in the State of New York and elsewhere, for the purpose of conducting and carrying on such manufactures and business. (d) To erect or have erected, to construct or have constructed, houses, works, buildings, storerooms, tenements, edifices, and structures of every description, and to rebuild, enlarge, improve and alter existing houses, works, buildings, storerooms, tenements, edifices, and structures of every description. (e) To buy, sell, exchange, dig, mine, excavate, prepare, manufacture, and generally to deal in and with all raw and manufactured substances, minerals, and materials, necessary or convenient for the uses, manufactures, and operations of the corporation, and to sell, exchange, and otherwise dispose of and turn to account all products and manufactures resulting from the same. Form ii. Building Materials (a) To manufacture, buy, sell, and generally to deal in and with cement, lime, plaster, and artificial stone; and to erect or purchase or lease kilns, store houses, factories, warehouses, and other structures necessary for the conduct of said business, and for the manufacture and storing of such materials and for other structural materials, supplies, and the implements and tools useful in connection therewith. (b) To acquire, own, hold, lease, maintain, establish, and operate quarries, brickyards, lime-kilns, cement and plaster mills, and furnaces, factories, and estab- lishments for the manufacture, preparation, production, and adaption of all kinds Cii. 2] SPECIAL CHARTER CLAUSES 1445 of structural material and supplies, and for the manufacture and repair of any and all machinery, tools, implements, vehicles, elevators, apparatus, and appliances used in or necessary in the prosecution of the said work, business, and undertaking of the corporation. Form 12. Cloaks and Garments (a) To manufacture cloaks, kimonos, dressing sacques, negligees, gowns, robes, waists, skirts, and all kinds of garments and wearing apparel for men, women, and children. (b) To conduct and carry on the business of cutting out, making, and prepar- ing clothing and wearing apparel of all kinds, and of all other articles which may be conveniently or advantageously handled in connection with the aforesaid business. (c) To buy, sell, import, export, and deal in and with woolen, cotton, silk, and other textile fabrics, and in any and all other materials useful or necessary in the manufacture of clothing and wearing apparel. Form 13. Contracting and Building (a) To make, enter into, perform, and carry out contracts for building, erect- ing, improving, constructing, altering, repairing, decorating, finishing and furnish- ing houses, buildings, warehouses, storerooms, edifices, works, tenements, and structures of every kind and description; to carry on in all their respective branches the business of builders, contractors, decorators, and such other trades and busi- nesses as pertain to or are connected with the general business of building and construction. (b) To take over, acquire, purchase, own, sell, lease, hire, hold, control, manage, maintain, and operate quarries, brickyards, lime-kilns, refineries, asphalt, cement and plaster mills, lumber yards, timber lands, saw mills, glass, metal and woodworking plants, pulp and paper mills, furnaces, factories, and establishments for the manufacture, preparation, and production of building supplies, material, furnishings, decorations, and furniture; and to buy, sell, and generally deal in and with all such articles and materials. (c) To act as agents, factors, brokers, commission merchants, carriers, con- tractors, builders, architects, decorators, surveyors, engineers, appraisers, lessees, managers of estate, or otherwise in entering into, undertaking, performing, and carrying out and conducting any and all things set forth in this certificate as objects, purposes, or powers that it may do for itself; and to exercise its powers to the same extent that natural persons might do, and in any part of the world to the full extent permitted to corporations organized under the Business Corporations Law of the State of New York. Form 14. Cotton and Textile Fabrics (a) To carry on the business of buying, selling, storing, ginning, baling, com- pressing, shipping, and otherwise dealing in and with cotton of all kinds; and of making, producing, refining, adapting, preparing, buying, selling, storing, and otherwise dealing in and with cotton-seed oils and other oils; and of buying, selling storing, and otherwise dealing in and with cotton-seed; and in making, adapting, 1446 CORPORATE FORMS [Bk. IV- preparing, buying, selling, storing, and otherwise dealing in and with all products and by-products of cotton and cotton-seed, and in utilizing the same to the profit and advantage of the corporation. (b) To grow, purchase, deal in and with, manufacture, prepare for market, and market, cotton, flax, hemp, wool, silk, and other fibrous materials of all kinds; to manufacture, deal in and with all the products and by-products of said materials and all articles or products or by-products consisting in part of such materials, or any products or by-products thereof; to bleach, dye, print, and otherwise manipu- late and treat in such manner as may be desired, and spin, comb, weave, and pre- pare for market, either wholly or in part, and market and deal in any of such materials, products, by-products or articles; and to do all things and engage in any and all kinds of business and in all parts of the world which in the opinion of the corporation may be necessary, ancillary, incidental, profitable, or proper to or in connection with said business or any portion thereof. (c) To buy, sell, manufacture, operate, and generally deal in and with any and all devices, machinery, and apparatus for ginning, baling, compressing, pre- paring, or otherwise manufacturing or treating cotton, flax, hemp, wool, silk, and other fibrous or other materials; and to do all business connected with and collateral thereto, including the selling, shipping, and warehousing of the products. (d) To erect, construct, and equip cotton storage warehouses and general warehouses, and to purchase and lease the same, or rights to or interests therein, and to conduct the business of storage and warehousing, and all the business neces- sarily or impliedly incidental thereto or profitable in connection therewith, and to further carry on the business of general warehousing in all its several branches; to construct, purchase, or otherwise acquire, and to operate and maintain, all or any means of conveyance for the transportation by land or by water of any and all products, goods, or manufactured articles of the corporation; to issue negotiable certificates, debentures, warrants, and other evidences of indebtedness upon com- modities stored in the corporation's warehouses and to persons warehousing goods with the corporation; and to make advances or loans of its own funds or as the agent for others upon the security of such goods or otherwise; to manufacture, sell, and trade in all materials, apparatus, and appliances usually dealt in by ware- housemen; and generally to carry on and undertake any business undertaking, transaction, or operation commonly carried on or undertaken by warehousemen, or any business which may, in the opinion of the corporation, be necessary, ancillary, incidental, profitable, or proper to or in the carrying on of said business or any part thereof, without any restrictions whatsoever. (See also Form 53.) . Form 15. Dairy and Farm Products (a) To buy, sell, and generally deal in and with milk; to condense, preserve and evaporate the same, and to manufacture butter, cheese, and other milk prod- ucts; to sell and handle fresh milk, eggs, butter, and all kinds of farm and dairy products; and to deal generally in and with food products of every kind and de- scription, including cereals and cereal products, meats, fish, vegetables, fruit of all kinds or preserved goods, and all kinds and descriptions of food preparations. (b) To lease, build, purchase, or otherwise acquire storehouses, packing houses, and canning factories for handling and storing milk, butter, cheese, eggs, vegetables, poultry, and all other food, farm and dairy products, and to sell or otherwise dis- pose of the product of such packing houses and factories. (c) To conduct and carry on any other business, manufacturing or otherwise, which may seem advantageous or useful in connection with the general business Ch. 2] SPECIAL CHARTER CLAUSES 1447 of the Company, and to manufacture, market, or prepare for market, any goods or commodities which the Company may use in connection with its business. (d) To protect the products of the company by trade-marks, trade-names, or any distinguishing name or title, and to acquire and take over any trade-marks, patent rights, processes, formulae, and apparatus useful or convenient in the conduct of the said business of the corporation. Form 1 6. Department Store (a) To establish, conduct, and carry on the general business of a department store and mail order business; and in connection therewith to carry on all or any of the trades and businesses of dry-goods merchants, cloth manufacturers, furriers, haberdashers, hosiers, milliners, dress-makers, cloak-makers, mantua-makers, tailors, hatters, clothiers, furnishers, outfitters, glovers, lace manufacturers, feather- dressers, boot and shoemakers, saddlers, harness-makers, cabinet-makers, uphol- sterers, jewelers, gold and silversmiths, watch and clock-makers, booksellers, restaurant keepers, tobacconists, cigar makers, confectioners, barbers, hair- dressers, photographers, printers, publishers, engravers, stationers, decorators, chemists, druggists. (b) Generally to buy, sell, import, export, manufacture, and deal in and with textile fabrics, leather goods, household and office furniture, ironmongery, hard- ware, tools, implements, machinery, china, glassware, crockery, pottery and utensils, notions, fancy goods, soaps, perfumery, drugs, medicines, chemicals and toilet articles, precious stones, jewelry, ornaments, watches, clocks, plated goods, foods, groceries, meats, fish, vegetables, fruits, provisions, supplies, dairy products, candies, confections, books, periodicals, pictures, works of art, bicycles, motor cycles, automobiles, motor boats, sporting goods, photographic supplies, domestic, trained and fancy animals and birds, and all kinds and descriptions of goods, wares, and commodities. (c) To advertise by all legitimate methods; to carry on the business of print- ing, publishing, engraving, bookbinding, designing, and producing and reproducing printing, writing, drawing, and impressions of all kinds; to buy, sell, manufacture, and deal generally in and with paper, envelopes, books, periodicals, magazines and advertising, printed and duplicated materials of all kinds, and with all supplies, stationery, and materials useful in connection with the business of advertising, printing, and publishing. (d) To apply for, obtain, purchase, lease, or otherwise acquire, and to register, hold, own, use, operate, and manufacture under, and to sell, assign, grant licenses in respect of, or otherwise dispose of and turn to account and profit, any and all trade-marks, improvements, processes, formulae, trade secrets, rights, franchises, licenses, inventions, contrivances, devices, appliances, brands, labels, patterns, and models, whether secured under letters patent in the United States or in any foreign country, or otherwise or in any other manner. Form 17. Drugs (a) To prepare, compound, manufacture, buy, sell, import, export, and gen- erally deal in and with drugs, medicines, chemicals, perfumeries, soaps, toilet articles, druggists' sundries, wines, liquors, mineral and soda waters, proprietary articles, electrical and surgical apparatus, physicians' and hospital supplies, and all kinds of pharmaceutical, chemical, and medicinal preparations, compounds, and materials. 1448 CORPORATE FORMS [Bk. IV- (b) To conduct and carry on in all its branches the business of chemists, druggists, and manufacturers and dealers in medical, chemical, pharmaceutical and other compounds, preparations, and materials, and in all supplies, mechanisms, apparatus, and implements used in such business or in connection therewith. (c) To prepare, manufacture, and sell the facial preparation known as "Rose Cre"me," and generally to buy, sell, manufacture, prepare, and deal in and with fine perfumeries, toilet preparations, and all such drugs, unguents, chemicals, and other materials as may be used or handled in connection therewith. (d) To buy, sell, combine, prepare, manufacture, and generally to deal in and with all manner of chemicals, chemical products, drugs, and compounds and preparations thereof; and to patent, register, or otherwise protect the same. Form 18. Dry-Goods To buy, sell, import, export, and to deal generally in and with all kinds of textile goods, wares and merchandise; and to prepare, manufacture and deal in all kinds of dry-goods, cloths, and textile fabrics and garments and other manu- factures of the same; and to conduct and carry on the general wholesale and retail dry -goods and white goods business in all its branches; and to conduct and carry on any form of manufacturing or mercantile enterprise necessary or incidental to the general busines of the Company. (This may be added to as desired from Form 16.) Form 19. Electrical Supply Company (a) To manufacture, prepare, construct, erect, install, and build electrical devices, motors, dynamos, batteries, meters, supplies, apparatus, machinery, improvements, appliances, and plants of all descriptions; and to buy, sell, import, export, and generally deal in and with the same, and all tools, stock, supplies, and material useful in connection therewith. (b) To carry on the business of electrical and mechanical engineers; to design, construct, enlarge, repair, improve, and manufacture all kinds of plants, engines, and machines; generally to work and operate as tool-makers, brass founders, metal workers, millwrights, machinists, iron and steel converters, smiths, builders, metal- lurgists; to buy, sell, repair, manufacture, and deal in machinery, implements, rolling stock, and hardware of all kinds; and to build, construct, and repair rail- roads, water, gas, and electric works, bridges, viaducts, piers, and works and structures of all kinds. Form 20. Engineering Mechanical (a) To conduct and carry on the business of mechanical engineers, and to design and construct plants, engines, machines, tools, and apparatus of all kinds. (b) To manufacture, buy, sell, and generally deal in tools, implements, and machinery and hardware of all kinds. (c) To operate and do business as tool-makers, brass founders, metal-workers, millwrights, machinists, smiths, builders, and mechanical engineers. (Add to as desired from Forms 29, 30, 36 and 38.) Ch. 2] SPECIAL CHARTER CLAUSES 1449 Form 21. Express and Delivery (a) To collect, receive, distribute, and deliver goods, merchandise, parcels, packages, baggage, and express matter, and to do a general cartage and delivery business in the City of Greater New York and elsewhere; to contract with express or railroad or other companies for the collection, transportation, or distribution of goods, merchandise, freight and express matter in said city and elsewhere, and to perform all such contracts. (b) To buy, sell, manufacture, and otherwise acquire, and to use, repair, store, operate, lease, let out, and otherwise employ and utilize cars, trucks, wagons and other vehicles and conveyances designed for the carriage and transportation of goods, freight, and merchandise of all kinds. (c) To do a general trucking and expressing business; to receive, handle, ship, forward, and transport goods, wares, merchandise, and freight of all kinds. Form 22. Films and Motion Pictures (a) To make, design, prepare, stage, and arrange for all manner of plays, dramas, and exhibitions, suitable for reproduction as photo-plays, motion pictures, or film reproductions of any kind. (b) To make, prepare, deal in, and lease or sell photo-plays and motion picture films, and to prepare and take pictures, photographs, plates, and films, and to deal in, lease, or sell the same. (c) To purchase, secure on royalty, or otherwise acquire, scenarios, plans for photo-plays, manuscripts for plays, and representations, and to employ actors, and other persons skilled in staging and reproducing such photo-plays and motion pictures, and to do all things necessary or convenient in taking, making, develop- ing, and exhibiting photo-plays and moving pictures and film representations. (d) To make, buy, lease, or otherwise acquire all kinds of photographic and moving picture devices, cameras, apparatus, and machinery, and to own, main- tain, and operate the same, and to conduct and carry on the business of making, selling, and leasing films for all kinds of photo-plays and moving pictures. (e) To buy, sell, lease, and operate halls, theaters, opera houses, and all lo- cations and edifices suitable for the exhibition of motion pictures and photo-plays, and in all such halls, rooms, and spaces to use and operate and conduct exhibitions of moving pictures, or to give concerts, plays, exhibitions, and other public enter- tainments of all kinds. Form 23. Furniture (a) To manufacture, buy, sell, export, import, exchange, and generally deal in and with all kinds of house, store, office, and other furniture, carpets, curtains, fixtures, and furnishing goods. (b) To engage generally in the business of furnishing, decorating, improving, and altering rooms, houses, stores, offices, and all kinds of halls, buildings, and apartments. (c) To purchase, lease, or otherwise acquire and hold lands, buildings, tene- ments, and factories for the offices, workshops, and storerooms of the Company, and to lease, mortgage, and convey such real estate in such manner as may appear for the best interests of the Company. 1450 CORPORATE FORMS [Bk. IV- Form 24. Gas and Electric Fixtures (a) To manufacture, buy, sell, import, export, and generally deal in and with gas and electrical fixtures, lamps, lamp shades, globes, pendants, chandeliers, lambrequins, and gas and electrical attachments of all kinds. (b) To buy, sell, import, export, prepare, and utilize glass, wood, metal, cloths, silks, leathers, and other materials for the manufacture of such gas, lamp, and electrical fixtures, and to do all things necessary or convenient in connection with such utilization. (This may be added to from Forms 26 and 33.) Form 25. Hardware (a) To buy, sell, import, export, and generally deal in and with all kinds of tools, hardware, and machinery; to establish, maintain, and operate shops and factories for the manufacture and construction of all kinds of tools, hardware, machines, and mechanical construction. (b) To buy, sell, and generally to deal in iron, steel, manganese, copper, zinc, brass, and other metals, and in any and all articles made of or partly con- sisting of metal, wood, and other materials, and to engage in the repair and manu- facture of all goods, wares, and commodities dealt in by the corporation. Form 26. Heating Apparatus (a) To manufacture gas, oil, and electric stoves, heating apparatus, cooking apparatus, lighting apparatus, and all devices for the utilization of gas, oil, and electricity and other agencies for cooking, lighting, and heating, together with all parts, fixtures, instruments, mechanisms, attachments, and machinery, incident to, or appertaining to, or to be used in connection with gas, oil, electricity, or other agencies used for the purposes of the business of this Company. (b) To apply for, obtain, purchase, or otherwise acquire, and to register, patent, or otherwise secure, any and all trade-marks, inventions, devices, improve- ments, and appliances, patented or otherwise, relating to, or applicable to, the use of gas, oil, electricity, or other agencies for cooking, heating, or lighting, or capable of being used in connection therewith; to own, hold, use, operate, manufacture under, introduce, sell, assign, or otherwise dispose of the same; and to do all other things as may be necessary or desirable to ^acquire, use, dispose of, and turn to account, any and all such patents, licenses, trade-marks, improvements, devices, and appliances. (c) To carry on the trade or business of buying, selling, renting, leasing, producing, preparing, adapting, manufacturing, and otherwise dealing in any and all kinds of gas, oil, and electrical devices, fixtures, mechanisms, machines, novel- ties, and supplies, and hardware of all kinds and descriptions, and of all materials, raw and manufactured, useful or desirable in connection with or relating to such trade or business; and to carry on any other manufacturing or mercantile business that can be advantageously conducted in connection with the said business. Ch. 2] SPECIAL CHARTER CLAUSES 1451 Form 27. Hotel (a) To plan, design, and construct buildings for hotel purposes or to buy, sell, and acquire the same; to conduct and carry on such hotel or hotels for the accom- modation of the public; and to rent private rooms, suites, and all accommodation necessary for that purpose. (b) To conduct and carry on the business of buying and selling cigars and tobacco, of providing meals and food for the general public, and to buy all things necessary in connection therewith. (c) To purchase, lease, or otherwise acquire lands, buildings, and real estate for hotel use; and to lease, mortgage, and convey such real estate in such manner as may appear to the best interests of the corporation. Form 28. Ice Company (a) To manufacture, buy, sell, store, and generally deal in and with ice and refrigerating materials and supplies, and to transact all legitimate business inci- dental thereto or in anywise connected therewith. (b) To carry on the business of refrigerating, cold storage, and general ware- housing, and all the business necessarily or impliedly incidental thereto; to man- ufacture, sell, and trade in all goods usually dealt in by warehousemen; to con- struct, hire, purchase, operate, and maintain all or any conveyances for the trans- portation in cold storage or otherwise by land or water of any or all products, goods, or manufactured articles; and to do all things incidental to the business of cold storage and warehousing. (See also Form 49.) Form 29. Inventions and Patents To apply for, purchase, or otherwise acquire, and to hold, own, use, operate, and to sell, assign, or otherwise to dispose of, to grant licenses in respect of or otherwise turn to account, any and all inventions, improvements, and processes used in connection with, or secured under letters patent of the United States or elsewhere, or otherwise; and, with a view to the working and development of the same, to carry on any business whether manufacturing or otherwise, which may be calculated directly or indirectly to effect these objects. Form 30. Inventions and Patents " To acquire the United States rights for the system of automatic signals devised by Henry H. Hardy of South Orange, New Jersey, together with the inventions, processes, apparatus and devices included thereunder or connected therewith; to take over such United States letters patent as may already have been issued for such inventions and improvements thereon; to procure United States letters patent for such other inventions and improvements as are not already so pro- tected; to hold all such letters patent, ana to operate and manufacture thereunder or to grant licenses in respect thereof, or to sell and assign the said patents, in whole or in part; or to dispose otherwise of and turn to account any or all of the 1452 CORPORATE FORMS [Bk. IV- same in such manner as may in the judgment of its Board of Directors be for the best interests of the Company. Form 31. Jewelry (a) To manufacture, buy, sell, import, and generally deal in and with gold and silverware, watches, jewelry, precious stones, opera glasses, chains, umbrellas, silver and plated ware, gold and silver ornaments, and all goods, wares, and mer- chandise usually dealt in by watch makers and jewelers. (b) To manufacture, repair, regulate, and put in order watches, clocks, jewelry, and gold and silver ware of all kinds; and to plate, polish, and perform all operations necessary in connection with the handling of jewelers' goods, wares, and supplies. Form 32. Leather (a) To manufacture, produce, and otherwise prepare, and to buy and other- wise acquire, sell, store, transport, distribute, dispose of, and deal in and with (i) leather, lumber, belting, and any and all other merchandise and commodities of whatsoever nature and character; and (2) any and all materials, machinery, appliances, products, and supplies proper or adapted to be used in or in connection with or incidental to the manufacture, production, or preparation of any of the articles, merchandise, and commodities aforesaid; and also (3) any and all com- modities and things which result from or are by-products of the manufacture, production, or preparation of leather, lumber, belting, or other merchandise or articles, or in the manufacture, production, or preparation of which any of the said articles may be a factor or an ingredient, or of which the same may be a com- ponent part. (b) To engage in any other manufacturing, warehousing, trading, or selling business of any kind or character whatsoever. (c) To acquire, dispose of, lease, and utilize, in the manner and to the extent permitted by law, lands, timber, bark, tanneries, mills, warehouses, plants, and other buildings and structures, machinery, supplies, and any and all articles and property, including good-will, which the corporation may deem to be necessary or convenient to the attainment or furtherance of any of its objects. Form 33. Lighting and Heating (a) To manufacture, buy, sell, and lease gas, oil, and electric devices, mechan- isms, and apparatus, for the production of light, heat, and power, and of all such piping, conductors, and accessories as are usual in connection therewith. (b) To manufacture, buy, sell, and deal in all kinds of goods, wares, tools, fixtures, and appliances that may be useful in the production or utilization of light, heat, and power from any source. (c) To construct, equip, and install engines, power plants, machines, appara- tus, and appliances for the manufacture, production, generation, and supplying of gas, light, heat, power, electricity, or other motive power; and to maintain, repair, improve, control, and operate the same. Ch. 2] SPECIAL CHARTER CLAUSES 1453 Form 34. Locks (a) To acquire the inventions and improvements of Owen T. Hartwell relating to locks and locking devices; to manufacture under the same; and to sell and dis- pose of the locks and devices so manufactured. (b) To manufacture, buy, sell, import, export, and generally deal in and with locks, fastenings, and attachments used in connection therewith. (c) To apply for, obtain, purchase, or otherwise acquire, and to register, hold, own, and sell or otherwise dispose of, trade-marks, improvements, inventions, processes, formulae, trade secrets, and apparatus of all kinds, whether secured under letters patent of the United States or any foreign country, or in any other Form 35. Lumber (a) To purchase or otherwise acquire, and to hold, lease, and sell timber, mineral, and other lands and the products thereof; to build, construct, and operate shops, sawmills, and factories for the handling of all timber and lumber and for planing, dressing, and preparing the various products of such lands for market; to buy, sell, import, export, and generally deal and trade in wood, lumber, logs, and timber and brick, stone, lime, and other building materials. (b) To conduct and transact its said business in any of the states, territories, colonies, or dependencies of the United States, and in any and all foreign countries, to have one or more offices therein, and therein to conduct its said business- Form 36. Manufacturing (General) (a) To design, manufacture, construct, repair, and to buy, sell, and deal in all tools, parts, machines, mechanisms, apparatus, and all goods, articles, and commodities, dealt in or sold by retailers, wholesalers, and exporters in the United States of America and its territories or colonies. (b) To purchase, lease, or otherwise acquire lands and buildings suitable for its purposes, and to erect, build, and maintain all such plants, buildings, and ware- houses, engines and machinery, and offices as it may require to manufacture, store, and sell its wares and commodities. (c) To purchase or otherwise acquire such patents, licenses, patent rights, processes, and improvements, and to operate under, or sell, lease, and grant licenses in respect of, as may from time to time be for the best interests of the corporation. Form 37. Meat and Cattle (a) To buy, sell, import, export, and deal in and with meat, live cattle, pigs, and sheep at wholesale or retail, in the United States or elsewhere, and to carry on the said trade or business of dealing in meats and meat products in all its branches; to erect and build abattoirs, cold storage warehouses, sheds, slaughter houses, packing houses, and other structures necessary or convenient for the purposes of the company. 1454 CORPORATE FORMS [Bk. IV- (b) To slaughter cattle, pigs, and sheep; to preserve meat and products there- of; to buy, sell, and generally deal in hides, fats, tallow, grease, and animal products. Form 38. Metal- Working (a) To work and operate as welders, tool-makers, brass founders, metal- workers, machinists, smiths, model-makers, and metallurgists. (b) To design, construct, enlarge, repair, improve, and manufacture all kinds of tools, parts, motors, machines, engines, devices, mechanisms, and inventions. (c) To buy, sell, lease, alter, repair, store, use, operate, manufacture, and deal in and with tools, motors, engines, machines, dynamos, appliances, and apparatus relating to or useful in connection with motor vehicles or motor machinery. Form 39. Mining (a) To buy, lease, or otherwise acquire mines, mining rights, quarries, and mineral lands of every kind, nature, and description, and to work, mine, prospect, develop, operate, and promote the same; to mine, quarry, and excavate copper, gold, silver, and other ores and metals and minerals of all descriptions. (b) To buy and sell, or otherwise deal with or to traffic in iron, steel, man- ganese, copper, and other metals, and cement, wood, lumber, and other materials, and any products thereof, and any articles consisting or partly consisting thereof. (cf To engage in any other manufacturing, mining, construction, or trans- portation business of any kind or character whatsoever, and to that end to acquire, hold, own, and dispose of any and all property, assets, stocks, bonds, and rights of any and every kind; but not to engage in any business hereunder which shall require the exercise of the right of eminent domain within the State of New Jersey. (d) To acquire by purchase, subscription, or otherwise, and to hold or to dispose of stocks, bonds, or any other obligations of any corporation formed for, or then engaged in or pursuing, any one or more of the kinds of business, purposes, objects, or operations above indicated, or owning or holding any property of any kind herein mentioned; or of any corporation owning or holding the stock or the obligations of any such corporation. Form 40. Oil The nature of the business of this corporation and the objects or purposes proposed to be transacted, promoted or carried on by it are as follows, namely: 1. To buy, contract for, lease, and in any and all other ways, acquire, take, hold and own, and to sell, mortgage, lease or otherwise dispose of lands, mining claims, mineral rights, oil wells, gas wells, oil lands, gas lands and other real prop- erty, and rights and interests in and to real property, and to manage, operate, maintain, improve, and develop the said properties, and each and all of them. 2. To buy, contract for, lease, and in any and all other ways, acquire, take, hold and own, and to sell, mortgage, lease, and otherwise dispose of all rights of way, easements, franchises, and rights thereto, and to deal in the same in every way. 3. To buy, contract for, lease, and in any and all other ways acquire, take, hold and own personal property of every character and description, and to sell, mortgage, lease and otherwise dispose of the same. Ch. 2] SPECIAL CHARTER CLAUSES 1455 4. To engage in any kind of manufacturing business and to buy, contract for, lease, construct and otherwise acquire, take, hold and own, and to sell, mortgage, lease or otherwise dispose of, manufacturing plants, and to manage, operate, main- tain, improve and develop the same. 5. To buy, construct, contract for, lease and in any and all other ways acquire, take, hold and own refineries for the treatment of petroleum and other mineral oils and gases; the tanks and other facilities for the storage thereof; the pipe lines and other facilities for the distribution thereof; and the manufacturing plants, works and appurtenances for the production, distribution and sale of petroleum, oil, gas and of any and all refinements and by-products thereof; to prospect for oil, to drill oil wells and to develop the same; to refine crude oil; to improve, maintain, operate and develop, and to sell, mortgage, lease or otherwise dispose of the said properties, and to sell or otherwise dispose of such petroleum, oil, and all refinements and by- products thereof. 6. To enter into, maintain, operate or carry on in all its branches the business of mining and of drilling, boring and exploring for, producing, refining, treating, distilling, manufacturing, piping, carrying, handling, storing and dealing in, buying and selling petroleum, oil, natural gas, asphaltum, bitumen, bituminous rock, and any and all other mineral and hydro-carbon substances, and any and all products or by-products which may be derived from said substances or either of them; and for such or any of such purposes to buy, contract for, lease and in any and all other ways acquire, take, hold, and own, and to sell, mortgage, lease and otherwise dis- pose of, and to construct, manage, maintain, deal in and operate mines, refineries, pipe lines, tanks, machinery, wharves, steam, sailing and other vessels or water- craft of every kind, character and description, and otherwise to deal in, operate, establish, promote, carry on, conduct and manage any and all other property and appliances that may in any wise be deemed advisable in connection with the busi- ness of the corporation or any branch thereof, or that may be deemed convenient at any time by the Board of Directors of the Corporation. 7. To do engineering and contracting in the designing, construction, improve- ment, extension, maintenance and repair of oil or gas plants, including pipelines, tanks and other appliances thereto appertaining; also in the opening, developing and operating of petroleum, gas and oil wells, both for the corporation and for others. 8. To manufacture, buy, sell and otherwise deal in gas and oil machinery and appliances; also, lumber, stone, brick, steel, iron and other materials in connection with the building, erection, construction, development, improvement, extension, maintenance and repair of the properties herein enumerated, both for this corpora- tion and for others. (From charter of Pacific Oil Company, Delaware.) Form 41. Opticians (a) To buy, sell, manufacture, and generally to deal in and with lenses, glasses, mirrors, and reflectors of all kinds and descriptions; and to .grind, polish, mount, and prepare the same for use in optical, surgical, medical, dental, photo- graphic, electrical, and scientific and mechanical work, and instruments of all kinds. (b) To buy, sell, manufacture, and generally to deal in and with optical, scientific, surgical, medical, dental, and experimental tools, appliances, apparatus, instruments, reflectors, microscopes, telescopes, spy-glasses, opera glasses, magni- fying glasses, spectacles, cameras, magic lanterns, stereopticons, stereoscopes, and similar wares and merchandise of all sorts and descriptions. 1456 CORPORATE FORMS [Bk. IV- Form 42. Paints and Painters' Supplies (a) To manufacture, prepare, and sell oils, turpentine, paints, painters supplies, and kindred articles. (b) To buy, sell, import, export, and generally deal in and with paints, oils, turpentine, and painters' supplies of all kinds. (c) To buy, manufacture, lease, and sell all raw materials, mills, machinery, and other articles useful or convenient in connection with the said business herein mentioned. Form 43. Periodical or Newspaper (a) To take over the publication known as the "CARLTON MONTHLY MAGA- ZINE," to print, publish, and issue the same; to secure and publish news and literary material suitable for the said periodical; and to do all things necessary in connec- tion with its publication and distribution. (b) Generally to carry on the business of owning and publishing newspapers, magazines, and other periodicals; and in connection therewith to carry on business as printers, bookbinders, stationers, photographers, lithographers, and such other businesses or manufactures as may be convenient or necessary. (c) To purchase, build, lease, construct, or otherwise acquire such buildings, offices, plants, and machinery as may be necessary o'ir useful to carry out the objects and purposes of this company. Form 44. Photographic Apparatus To buy, sell, manufacture, and generally deal in and with cameras, tripods, dry plates, films, photographic chemicals, sensitized papers, plate-holders, screens, slides, printing frames, and all other apparatus, devices, supplies, and materials used in the art of photography or in connection therewith. Form 45. Pianos and Musical Instruments To buy, sell, import, export, and generally deal in and with pianos, organs and other musical instruments; and in all things, fixtures, furniture, and appliances useful or convenient in connection with the said business for the use of musical instruments; to manufacture, buy, sell, import, and export any and all kinds of musical instruments, materials, and supplies for the same, musical articles, furni- ture, cases, or conveniences used in the production of music, or in connection with the operation of musical instruments. Form 46. Printing (a) To buy, sell manufacture, and carry on the business of printers, publishers, stationers, engravers, designers; and to engage generally in the art, trade, and Ch. 2] SPECIAL CHARTER CLAUSES 1457 business of printing, engraving, lithographing, and all other methods of printing, or producing or reproducing printing, engraving, drawings, paintings, pictures and representations and impressions of all kinds in color or otherwise. (b) To print, publish, bind, and buy, sell, and deal in books, papers, maga- zines, periodicals, and advertising and printed matter of all kinds; to hold, use, sell, circulate, distribute, and dispose of the same; and generally to do all things inci- dental to or connected with the business of printing and publishing. (c) To buy, sell, rent, manufacture, install, use, operate, and generally deal in and with machines, mechanisms, devices, apparatus, inventions, and improve- ments for printing, writing, duplicating, type-setting, type-making, linotyping, casting, or making type, making printing slugs, plates, platens, stereotypes, and all other things for use in or in connection with the printers' art, trade, and business. (d) To apply for, obtain, purchase, or otherwise acquire, and to register, hold, own, use, operate, sell, assign, or otherwise dispose of and turn to account and profit, any and all trade-marks, improvements, processes, formulae, trade secrets, inventions, and apparatus of all kinds, whether secured under letters patent of the United States or in any foreign country, or in any other manner. (e) To apply for, obtain, purchase, or otherwise acquire, and to own, hold, use, sell, assign, or otherwise dispose of and turn to profit and account, copyrights and publishing rights of all kinds. Form 47. Railroad Construction (a) To do all things necessary or useful in connection with the construction of railways, railway bridges, and railway terminals, and the doing of all things and the making of all contracts for such construction. (b) To deal in stocks, bonds, and other securities of railroad companies, and to purchase, hold, pledge, and sell the same. (c) To buy, sell, and deal in real estate, rights of way, and the selling or leasing of the same. (d) To promote and organize railroad corporations, to sell their stocks and other securities, and to secure finance for their construction. (e) To acquire franchises, concessions, rights of way, and other privileges to be utilized for railroads or railroad construction. Form 48. Real Estate (a) To take over and acquire all or any part or parts or interest or interests in the estate and property of Wilson D. Manning, deceased, to assume the payment of any notes, indebtedness, or obligations of such estate, and to hold, improve, lease, sell, and otherwise handle and dispose of the said estate and pr6perty as may appear to the advantage and profit of the corporation. (b) To take, purchase, or otherwise acquire, and to own, hold, sell, convey, exchange, hire, lease, pledge, mortgage, and otherwise deal in and dispose of all kinds of real estate, real property, personal property, chattels, chattels real, choses in action, notes, bonds, mortgages, and securities. (c) To conduct and transact business in any of the states, territories, colonies, or dependencies of the United States and in any and all foreign countries; to have ojie or more offices therein, and therein to hold, purchase, mortgage, and convey real and personal property without limit or restriction except as imposed by the local laws. 1458 CORPORATE FORMS [Bk. IV- (d) To do any and all things set forth in this certificate as objects, purposes, powers, or otherwise, to the same extent and as fully as natural persons might do, and in any part of the world as principals, agents, contractors, lessees, or otherwise. See also purposes in Form i.) Form 49. Refrigerating Company (a) To plan, design, lay out, construct, and contract to install plants, ma- chinery, factories, and apparatus for mixing, making, freezing, preparing, and mar- keting ices, ice-creams, and all kinds of frozen and refrigerated substances. (b) To contract and undertake the planning, designing, manufacture, and construction of ice, cold storage, and refrigerating plants, machinery, apparatus, and conveyances, and of all buildings, structures, piping, and storing facilities necessary or pertaining thereto. (c) To carry on a general contracting and engineering business in all its branches; particularly to carry on the business of refrigerating engineering; and to design, erect, construct, enlarge, repair, improve, and manufacture all kinds of ice, cold storage, and refrigerating plants, engines, machinery, insulation, and apparatus. (d) To carry on the business of ice-making, cold storage, refrigeration, and making ice-cream, and do all things incidental thereto; to buy, sell, construct, operate, and maintain ice plants, cold storage warehouses, refrigerating apparatus, and conveyances for the transportation in cold storage of all goods, products, and wares. (See also Form 28.) Form 50. Schools (a) To establish, organize, manage, and conduct schools and educational institutions, and to employ teachers, educators, and instructors, and to provide courses of study preparatory for business and professional life and for general in- formation and culture. (b) To erect, lease, or otherwise acquire suitable buildings and structures in which to conduct such schools and educational institutions, and to provide books, libraries, furniture, and apparatus for the same. (c) To establish and conduct institutes, lecture courses, correspondence and extension courses, training schools, home classes, and to use and adapt such other means as may from time to time seem effective in promoting the work of education. (d) To give such diplomas, certificates, and other evidences of proficiency as may be compatible with the laws of the state, or such as may be hereafter authorized by the educational authorities of the =tate. (e) To establish scientific, business, technical, cultural, artistic, and musical courses of education and training; to secure, print, and publish books, charts, and courses of study to use in connection with such courses; and to do all other things necessary or convenient in connection with such educational work. Form 51. Securities Company (New York) (a) To buy, sell, hold, and generally to deal in and with stocks, bonds, deben- tures, mortgages, and securities of all kinds; to borrow money, make loans, advance Ch. 2] SPECIAL CHARTER CLAUSES 1459 money on contracts, make investments, and generally act as investment brokers; to issue notes, bonds, securities, and debentures which may be secured by mortgage or otherwise upon property real and personal of the corporation under the provisions of Section 2 of the Stock Corporations Law of the State of New York; and to pur- chase, hold, improve, sell, lease, or exchange real estate. (b) To act as agents, factors, brokers, commission merchants, contractors, lessees, and managers of estates or otherwise in entering into, undertaking, per- forming, negotiating, executing, conducting, and transacting for persons, firms, and corporations upon commission or otherwise, any and all the things set forth in this certificate that it can do for itself; and to exercise all of its powers to the same extent that a natural person might do, and in any part of the world to the full extent permitted to corporations organized under the Business Corporations Law of the State of New York. (c) To purchase, acquire, hold, and dispose of the stocks, bonds, and other evidences of indebtedness of any corporation, domestic or foreign, and issue in exchange therefor its stock, bonds, or other obligations; and to exercise while owner of the stock of other corporations all the rights, powers, and privileges of ownership, including the right to vote thereon. (d) To guarantee or cause to be guaranteed the payment of dividends or interest on any bonds, stocks, debentures, or other securities of this corporation; and to guarantee or cause to be guaranteed the contracts and obligations of this corporation whenever proper or necessary for its business in the judgment of its Board of Directors. (See also Form 9.) Form 52. Smelting and Allied Operations (New Jersey) (a) To buy, lease, or otherwise acquire mines, mining rights quarries and mineral lands and claims of every kind, nature, and description, and to work, mine, prospect, develop, and promote the same; to mine, quarry, and excavate gold, silver, copper, and other o/es and metals and minerals of all descriptions. (b) To buy, lease, construct, own, control, operate, and maintain mills, works, and plants for the crushing, sampling, milling, smelting, reduction, and concen- tration of minerals and metal-bearing ores, and the extraction therefrom of all kinds of metals and mineral products and by-products, on its own account and as factor and agent for others. (c) To carry on the business of mining, milling, concentrating, converting, smelting, treating, preparing for market, reducing, buying, selling, and merchan- dising in gold, silver, copper, and other metals and metallic compounds, coal, coke, charcoal, and other fuels, and all products and by-products of all ores and minerals. (d) To treat, prepare, and manufacture, and to buy, sell, and generally to deal in iron, steel, manganese, coke, copper, lumber, and other materials, and all or any articles consisting of or partly consisting of metal, wood or other materials, and any and all products and by-products thereof. (e) To buy, sell, manufacture, produce, and dispose of all kinds of goods, wares, merchandise, manufactures, commodities, foodstuffs, drugs, furniture, machinery, tools, supplies, and agricultural products, and generally to engage in and carry on any forms of manufacturing or mercantile enterprise, necessary or incidental to the business of the Company. (f) To construct bridges, buildings, machinery, ships, boats, engines, cars, and other equipment, railroads, docks, slips, elevators, water-works, gas-works, electric- works, viaducts, aqueducts, canals, and other waterways, and any other means of transportation; and to sell the same, or otherwise dispose thereof;^ or to maintain 1460 CORPORATE FORMS [Bk. IV- and operate the same, except that the Company shall not maintain or operate any railroad or canal in the State of New Jersey. Form 53. Textile Fibers (a) To buy, sell, grow, prepare, manufacture, and generally deal in and with flax, hemp, jute, wool, silk, cotton, and fibers and fibrous materials of all kinds; to buy, sell, prepare, manufacture, and generally deal in all products and by-products of said materials and substances, or products and by-products consisting in part of such materials and substances; to bleach, dye, print, color, and otherwise treat and manipulate, and to spin, comb, weave, and prepare for market, either wholly or in part; and to buy, sell, market, and deal in any and all such products, by-prod- ucts, materials, manufactures, and substances; and to do all other things and engage in any and all kinds of business which may be necessary, ancillary, incidental, profitable, or convenient in connection with said business or any portion thereof. (b) To buy, sell, own, hold, use, operate, and generally to deal in and with all devices machines, mechanisms, and engines that may be useful or convenient in the treatment, preparation, manufacture, and manipulation of flax, hemp, jute, wool, silk, cotton, and other fibers and fibrous materials of all kinds. (See also Form 14.) INCLUSIVE CLAUSES The use of these general clauses is shown in the charters of Forms i to 4. In some states clauses of this kind, giving vast and almost unlimited powers, are not allowed. Form 54. To Buy and Hold Real Estate To purchase or otherwise acquire, and to own, develop, sell, mortgage, or otherwise dispose of real estate, real property, and all interests and rights therein, without limit or amount, and to the same extent as natural persons might or could do, and in any part of the world. Form 55. To Conduct Any Other Business To conduct and carry on any other business, manufacturing or otherwise, which may be capable of being profitably carried on in connection with the Com- pany's business, or to carry on any business that is adapted directly or indirectly to add to the value of the Company's property and the profits of its authorized business. Form 56. To Acquire Other Enterprises To buy or otherwise to acquire any other enterprise adapted to be carried on in connection with the Company's business, together with the good-will, rights, Ch. 2] SPECIAL CHARTER CLAUSES 1461 property, and assets of all kinds thereto pertaining, and in connection therewith to assume any of the liabilities of any person, firm, or corporaton, and to pay for the same in cash, stock, debentures, or other securities of the Company. Form 57. To Carry on Business in Other States To conduct its business and to have one or more offices, and to acquire, hold, mortgage, lease, and convey real and personal property, unlimitedly and without restriction, in any of the states or territories of the United States, or in any foreign place or country, so far as is permitted by the laws thereof. Form 58. To Promote Other Undertakings To promote or to aid in any manner, financially or otherwise, any corporation or association of which any stocks, bonds, or other evidences of indebtedness or securities are held directly or indirectly by this corporation; and for this purpose to guarantee the contracts, dividends, stocks, bonds, notes, and other obligations of such other corporations or associations; and to do any other acts or things de- signed to protect, preserve, improve or enhance the value of such stocks, bonds, or other evidences of indebtedness or securities. Form 59. To Enter into Contracts To contract freely with any person, firm, or corporation, private or public, and to carry out and fulfill contracts of every sort and kind, and to purchase, lease or otherwise acquire any and all rights, privileges, and franchises convenient or profitable to carry out in connection with the corporate purposes and corporate business of the Company. Form 60. To Borrow Money To borrow money from any person, firm, or corporation; to make and issue, notes, bills, bonds, debentures, and other evidences of indebtedness of all kinds, and to secure the same by pledge, mortgage, or otherwise, without limit as to amount, and to provide for payment of the same by deposited cash, sinking funds, or otherwise. Form 61. To Acquire the Company's Own Stock The corporation may utilize and apply its surplus earnings or profits authorized by law to be so reserved, to the purchase or acquisition of its own capital stock, from time to time, and in such manner as may be legal and equitable as to other stockholders, and upon such terms as its Board of Director shall determine. 1462 CORPORATE FORMS [Bk. IV- Form 62. To Acquire Stock of Other Companies To hold, purchase, or otherwise acquire, and to sell, assign, transfer, mortgage, pledge, or otherwise dispose of, shares of the capital stock and securities created by any other corporation or corporations, and while the holder thereof to exercise all the privileges of ownership including the right to vote thereon. Form 63. Strengthening Clause To do any or all of the things in this certificate set forth as objects, purposes, powers, or otherwise, to the same extent and as fully as natural persons might or could do, and in any part of the world, as principals, agents, trustees, or otherwise. Form 64. Interpretation Clause The objects and powers specified in this certificate of incorporation shall except where expressly limited, be in nowise limited or restrained by inference from the terms of any other clause in any other part of this charter, but the objects and powers specified in each of the clauses of this charter shall be regarded as inde- pendent and separate purposes and powers of the corporation. CHAPTER III BY-LAW FORMS The comprehensive and detailed by-laws required for the operation of a large corporation are neither necessary nor desir- able for those of lesser size. For most small corporations the following short set of by-laws, prepared for the use of a New York corporation will be found adequate, and may be easily changed to meet special requirements of other states or other corporations. It may be noted that in New York and some other states, inspectors of election are required by the statute law for the annual election of directors; also that in New York State, at the annual meeting of stockholders, the by-law specifications for stockholders' quorums will not apply in the election of direc- tors, as the statutes specifically provide that the directors shall be "elected by a plurality of the votes at such election," regard- less of whether a quorum be present, and, if at a special meeting for the election of directors, "members attending shall con- stitute a quorum." 1 Form 65. By-Laws Short BY-LAWS of the MAYSWOOD MOTOR COMPANY New York City ARTICLE I. STOCK t. Certificates of Stock shall he issued in numerical order from the stock certifi- cate book to each stockholder of record whose stock has been paid in full, be signed 1 For general discussion of by-laws, see Book I, Part VI, "The By-Laws." U63 1464 CORPORATE FORMS [Bk. IV- by the President and Treasurer, and be sealed by the Secretary with the corporate seal. A record of each certificate issued shall be kept on the stub thereof. 2. Transfers of Stock shall be made only upon the books of the Company, and before a new certificate is issued the old certificate must be surrendered for cancella- tion. The stock books of the Company shall be closed for transfer twenty days before general elections and ten days before dividend days. 3. The Treasury Stock of the Company shall consist of such issued and out- standing stock of the Company as may be donated to the Company or otherwise acquired, and shall be held subject to disposal by the Board of Directors. Such stock shall neither vote nor participate in dividends while held by the Company. ARTICLE II. STOCKHOLDERS 1. The Annual Meeting of the stockholders of this Company shall be held in the principal office of the Company, in New York City, on the second Monday in January of each year, at 3 P.M. if not a legal holiday, but if a legal holiday, then on the next business day following. 2. Special Meetings of the stockholders may be called at the principal office of the Company at any time by resolution of the Board of Directors, or upon written request of stockholders holding one-third of the outstanding stock. 3. Notice of Meetings, written or printed, shall be prepared and mailed to the last known post-office address of each stockholder not less than ten days before any regular or special meeting of stockholders, and if for a special meeting, such notice shall state the object or objects thereof. No failure of or irregularity of notice of any regular meeting shall invalidate such meeting or any proceeding thereat. 4. A Quorum at any meeting of the stockholders shall consist of a majority of the voting stock of the Company, represented in person or by proxy. A majority of such quorum shall decide any question that may come before the meeting. 5. The Election of Directors shall be held at the annual meeting of stockholders, and shall, after the first election, be conducted by two inspectors of election, appointed by the President for that purpose. The election shall be by ballot and each stockholder of record shall be entitled to cast one vote for each share of stock held by him. 6. The Order of Business at the annual meeting, and, as far as possible, at all other meetings of the stockholders, shall be: 1. Calling of roll 2. Proof of due notice of meeting 3. Reading and disposal of any unapprpved minutes 4 Annual reports of officers and committees 5. Election of directors 6. Unfinished business 7. New business 8. Adjournment ARTICLE III. DIRECTORS 1. The Business and Property. of the Company shall be managed by a Board of five Directors, who shall be stockholders of the Company and who shall be elected annually by ballot by the stockholders for the term of one year, and shall serve until the election and acceptance of their duly qualified successors. Any vacancies may be filled by the Board for the unexpired term. Directors shall receive no compensation for their services as such. 2. The Regular Meetings of the Board of Directors shall be held in the principal office of the Company in New York City on the third Tuesday of each month, at 3 P.M. if not a legal holiday, but if a legal holiday, then on the next business day following. Ch. 3] BY-LAW FORMS 1465 3. Special Meetings of the Board of Directors may be held in the principal office of the Company in New York City at any time on call of the President, or of any three members of the Board, or may be held at any time and place without notice, by unanimous written consent of all the members, or with the presence and participation of all members at such meeting. 4. Notices of both regular and special meetings, save when held by unanimous consent or participation, shall be mailed by the Secretary to each member of the Board not less than five days before any such meeting, and notices of special meet- ings shall state the purposes thereof. No failure or irregularity of notice of any regular meeting shall invalidate such meeting or any proceeding thereat. 5. A Quorum at any meeting shall consist of a majority of the entire member- ship of the Board. A majority of such quorum shall decide any question that may come before the meeting. 6. Officers of the Company shall be elected by ballot by the Board of Directors at their first meeting after the election of Directors each year. If any office becomes vacant during the year, the Board of Directors shall fill the same for the unexpired term. The Board of Directors shall fix the compensation of the officers and agents of the Company. 7. The Order of Business at any regular or special meeting of the Board of Directors shall be: 1. Reading and disposal of any unapproved minutes 2. Reports of officers and committees 3. Unfinished business 4. New business 5. Adjournment ARTICLE IV. OFFICERS 1 . The Officers of the Company shall be a President, a Vice-President, a Secre- tary, and a Treasurer, who shall be elected for one year and shall hold office until their successors are elected and qualify. The position of Secretary and Treasurer may be united in one person. 2. The President shall preside at all meetings, shall have general supervision of the affairs of the Company, shall sign or countersign all certificates of stock, contracts, and other instruments of the Company authorized by the Board of Directors, except as otherwise directed by the board; shall make such reports to the Directors and stockholders as he may deem necessary or as may be required of him, and perform all such other duties as are incident to his office or are properly required of him by the Board of Directors. In the absence or disability of the President, the Vice-President shall exercise all his functions. 3. The Secretary shall issue notices for all meetings of stockholders and direc- tors, shall keep their minutes, shall have charge of the seal and the corporate books, shall sign, with the President, such instruments as require such signature, and shall make such reports and perform such other duties as are incident to his office, or are properly required of him by the Board of Directors. 4. The Treasurer shall have the custody of all moneys and securities of the Company and shall keep regular books of account and balance the same each month. He shall sign or countersign such instruments as require his signature, shall perform all duties incident to his office or that are properly required of him by the Board, and shall give bond for the faithful performance of his duties in such sum and with such sureties as may be required by the Board of Directors. ARTICLE V. DIVIDENDS AND FINANCE i. Dividends shall.be declared from the surplus profits of the Company at such times as the Board of Directors shall direct, and no dividend shall be declared that will impair the capital of the Company. 1466 CORPORATE FORMS [Bk. IV- 2. The Moneys of the Company shall be deposited in the name of the Company in such banks or trust companies as the Board of Directors shall designate, and shall be drawn out only by check signed by the Treasurer and countersigned by the President ARTICLE VI. SEAL i. The Corporate Seal of the Company shall consist of two concentric circles between which is the name of the Company, and in the centre shall be inscribed "Incorporated 1922, New York," and such seal, as impressed on the margin hereof, shall be the Corporate Seal of the Company. ARTICLE VII. AMENDMENTS 1. These By-Laws may be amended, repealed, or altered, in whole or in part, by a majority vote of the entire outstanding stock of the Company, at any regular meeting of the stockholders, or at any special meeting where such action has been announced in the call and notice of such meeting. 2. The Board of Directors shall not alter or repeal any by-laws adopted by the stockholders of the Company, but may adopt additional by-laws in harmony therewith. The following by-laws for a New Jersey corporation are more detailed and comprehensive than those just shown, providing for a much higher degree of organization. They will be found adequate for most corporations of moderate size and may be readily modified to meet the requirements of any particular state. Form 66. By-Laws Extended BY-LAWS of the OGDEN IRON AND STEEL COMPANY Incorporated under the Laws of New Jersey ARTICLE I. STOCK SEC. i. Certificates of Stock Each stockholder of the company whose stock has been paid for in full shall be entitled to a certificate or certificates showing the amount of stock of the Com- pany standing on the books in his name. Each certificate shall be numbered, bear the signatures of the President and Treasurer and the seal of the Company, and be issued in numerical order from the stock certificate book. A full record of each certificate of stock, as issued, shall be entered on the corresponding stub of the stock certificate book. SEC. 2. Transfers of Stock Transfers of stock shall be made upon the proper stock books of the Company, and must be accompanied by the surrender of the duly indorsed certificate or Ch. 3] BY-LAW FORMS 1467 certificates representing the transferred stock. Surrendered certificates shall be canceled and attached to the corresponding stubs in the stock certificate book and new certificates issued to the parties entitled thereto. The stock books shall be closed to transfers twenty days before general elections and twenty days before dividend days. SEC. 3. Lost Certificates The Board of Directors may order a new certificate or certificates of stock to be issued in the place of any certificate or certificates of the Company alleged to have been lost or destroyed, but in every such case the owner of the lost certifi- cate or certificates shall first cause to be given to the Company a bond in such sum, not less than the par value of such lost or destroyed certificate or certificates of stock, as said Board may direct, as indemnity against any loss that the Company may incur by reason of such replacement of the lost certificate or certificates; but the Board of Directors may, in their discretion, refuse to replace any lost certificate of stock, save upon the order of some court having jurisdiction in such matter. SEC. 4. Stock and Transfer Books The stock and transfer books of the Company shall be kept in its principal office, No. 525 Main Street, East Orange, New Jersey, and shall be open during business hours to the inspection of any stockholder of the Company. All other books and records of the Company shall be kept in its office in New York City, and shall include a stock book, which shall be open during business hours to the inspection of any stockholder or judgment creditor of the Company. SEC. 5. Preferred Stock The capital stock of this Company shall be One Hundred Thousand Dollars ($100,000), consisting of One Thousand (1,000) Shares, each of the par value of One Hundred Dollars ($100), and of these, Five Hundred (500) Shares shall be preferred stock, and Five Hundred (500) Shares shall be common stock. The said preferred stock of the Company shall receive from its net earnings a Six Per Cent (6%) annual cumulative dividend before any dividends are paid upon the common stock, but the holders of preferred stock shall not be entitled to vote at the meetings of the stockholders of the Company. SEC. 6. Treasury Stock All issued and outstanding stock of the Company that may be donated to or be purchased by the Company shall be termed treasury stock, and shall be held subject to disposal by action of the Board of Directors. Such stock shall neither vote nor participate in dividends while held by the Company. ARTICLE II. STOCKHOLDERS SEC. i. Annual Meetings The regular annual meetings of the stockholders shall be held in the office of the Company, at No. 525 Main Street, East Orange, New Jersey, at n A.M., on the second Monday of January in each year if not a legal holiday, but if a legal holiday, then on the next business day following. At this meeting the Directors for the ensuing year shall be elected, the officers of the Company shall present their annual reports, and the Secretary shall have on file for inspection and reference, an alphabetical list of the stockholders of the Cornpany, giving the amount of stock " held by each, as shown by the stock books twenty days before the date of such annual meeting. SEC. 2. Special Meetings Special meetings of the stockholders may be held at any time, in the office of the Company, pursuant to a resolution of the Board of Directors, or to a call 1468 CORPORATE FORMS [Bk. IV- signed by stockholders holding a majority of the voting stock of the Company. Calls for special meetings shall specify the time, place, and object or objects thereof, and no other business than that specified in the call shall be considered at any such meeting. SEC. 3. Notice of Meetings A written or printed notice of every regular or special meeting of the stock- holders, stating the time and the place, and, in case of special meetings, the objects thereof, shall be prepared and mailed by the Secretary, postage prepaid, to the last known post-office address of each stockholder, at least ten days before the date of any such meeting No failure or irregularity of notice of any regular meeting shall invalidate the same or any proceeding thereat. SEC. 4. Voting Only stockholders of record of the common stock of the Company shall be entitled to vote at the regular and special meetings of stockholders. At such meetings each stockholder shall be entitled to one vote for each share of stock standing on the books of the Company in his name. SEC. 5. Election of Directors At the first meeting of the stockholders and at each annual meeting of the stockholders thereafter, a Board of seven Directors shall be elected, who shall serve until the election and acceptance of their duly qualified successors. All elections for Directors shall be by ballot, and the candidates, to the number to be elected, receiving the highest number of votes, shall be declared elected. If for any reason Directors are not elected at the annual meeting of stock- holders, a special meeting shall be called for the purpose within thirty days there- after, at which Directors shall be elected in all respects as at the annual meeting. Two inspectors of election shall be appointed by the President to conduct the election of Directors to serve for the ensuing year. These inspectors shall be sworn to the faithful discharge of their duty and shall then take charge of the election. No person who is a candidate for the office of Director shall act as an inspector of election. SEC. 6. Quorum A majority of the outstanding stock, exclusive of treasury stock, shall be necessary to constitute a quorum at meetings of stockholders. When a quorum is present at any meeting, a majority of the stock represented thereat shall decide any question brought before such meeting. In the absence of a quorum those present may adjourn the meeting from day to day, but until a quorum is secured no business may be transacted. SEC. 7. Proxies Any stockholder entitled to vote may be represented at any regular or special meeting of stockholders by duly executed proxy. Proxies shall be in writing and properly signed, but shall require no other attestation. No proxy shall be recog- nized unless executed within eleven months of the date of the meeting at which it is presented. SEC. 8. Officers of Meetings The President, if present, shall preside at all meetings of the stockholders. In his absence, the next officer in due order who may be present shall preside. For the purposes of these by-laws, the due order of officers shall be as follows : President, Vice-President, Treasurer, and Secretary. The Secretary of the Company shall keep a faithful record of the proceedings of all stockholders' meetings. Ch. 3] BY-LAW FORMS 1469 SEC. 9. Order of Business The order of business at the annual meeting, and, so far as practicable, at all other meettings of the stockholders, shall be as follows: 1. Calling of roll 2. Proof of due notice of meeting 3. Reading and disposal of any unapproved minutes 4. Annual reports of officers and committees 5. Election of directors 6. Unfinished business 7. New business 8. Adjournment ARTICLE III. DIRECTORS SEC. i. Number and Authority A Board of seven Directors shall be elected, who shall have entire charge of the property, interests, business, and transactions of the Company, with full power and authority to manage and conduct the same. SEC. 2. Qualifications No person shall be elected, nor shall be competent to act as a Director of this Company, unless he is at the time of election the holder of record of at least one share of its stock. At least one of the Directors of the Company must be resident in the Sta'te of New Jersey. SEC 3. Vacancies Any vacancy occurring in the Board of Directors may be filled for the unex- pired term by a majority vote pf the remaining members. In event of the member- ship of the Board falling below the number necessary for a quorum, a special meet- ing of the stockholders shall be called and such number of Directors shall be elected thereat as may be necessary to restore the membership of the Board to its full number. SEC. 4. Regular Meetings The regular meetings of the Board of Directors shall be held in the office of the Company, in the City of New York, at 3 P.M., on the second Monday of each month if not a legal holiday, but if a legal holiday, then on the next business day following. SEC. 5. Special Meetings Special meetings of the Board of Directors may be held at any time, in the office of the Company in the City of New York, on the written call of the President or of any three members of the Board. Special meetings may be held at any time and place and without notice, by unanimous consent of the Board. SEC. 6. Notice of Meetings The Secretary shall notify each member of the Board of all regular or special meetings, by mailing to each member's last known post-office address, postage prepaid, at least five days before any such meeting, a written or printed notice thereof, giving the time, place, and, in case of special meetings, the objects thereof, and no other business shall be considered at any special meeting than shall have been so notified to the members. No failure or irregularity of notice of any regular meeting shall invalidate the same or any proceeding thereat. SEC. 7. Quorum A majority of the Board of Directors shall constitute a quorum, and a majority of the members in attendance at any Board meeting shall, in the presence of a 1470 CORPORATE FORMS [Bk. IV- quorum, decide its action. A minority of the Board present at any regular or special meeting may, in the absence of a quorum, adjourn to a later date, but may not transact any business. SEC. 8. Election of Officers At the first meeting of the Board of Directors after the election of Directors each year, a President, Vice-President, Secretary, Treasurer, and General Manager shall be elected to serve for the ensuing year and until the election of their respective successors. Election shall be by ballot, and a majority of the votes cast shall be .necessary to elect. If not detrimental to the business or operations of the Com- pany, any two offices may be conferred upon one person. The Directors shall fix the compensation of officers subject to any limitations of the Charter and the By- Laws. Any vacancies that occur may be filled by the Board for the unexpired term. The Board shall have the right to remove any officer for cause by a two- thirds vote of the entire membership of the Board. SEC. 9. Compensation of Directors Each Director shall receive the sum of five dollars for his attendance at any regular or special meeting of the Board of Directors, but shall receive no other salary or compensation for his services as a Director of the Company. SEC. 10. Power to Pass By-Laws The Board of Directors shall have no power to amend, alter, or repeal by-laws adopted by the stockholders of the Company, but may pass such additional by-laws in conformity therewith as may be necessary or convenient to facilitate the business of the Company. SEC. n. Executive Committee The President, Vice-President, and Treasurer shall together constitute an Executive Committee, which shall be a part of the permanent executive organiza- tion of the Company, and shall, in the interim between meetings of the Board of Directors, exercise all the powers of that body, in accordance with the general policy of the Company and the directions of the Board. Meetings of the Executive Committee shall be held on call of the President, or of any two members of the Committee. All of the members of the Committee must be duly notified of meetings, and a majority of the members shall constitute a quorum. The Executive Committee shall keep a record of all meetings and actions of the Committee, and such records shall at all times be open to the inspection of any Director. SEC. 12. Corporation Offices The principal office of the Company within the State of New Jersey shall be at 525 Main street, East Orange, and the agent therein and in charge thereof upon whom process may be served shall be the Registration Trust Company of New Jersey. An office shall also be maintained in New York City, and such other offices for the transaction of its business shall be maintained at such other places in or out- side of the State of New Jersey, as may be determined upon by the Board of Directors. SEC. 13. Order of Business The regular order of business at meetings of the Board of Directors shall be as follows: 1. Reading and dispqjsal of any unapproved minutes 2. Reports of officers and committees 3. Unfinished business 4. New business 5. Adjournment Ch. 3] BY-LAW FORMS 1471 ARTICLE IV. OFFICERS SEC. i. Enumeration, Election, and Qualification The officers of the Company shall be a President, Vice-President, Treasurer, Secretary, and General Manager. These officers shall be elected by the Board of Directors at the first regular meeting after the election of directors each year, and shall hold office for the term of one year, and until their respective successors are duly elected and qualify. The President and Vice-President shall be elected from from the Directors of the Company. SEC. 2. The President The President, when present, shall preside at all meetings of the stockholders and of the Board of Directors; shall sign all certificates of stoqk; shall sign or countersign, as may be necessary, all such bills, notes, checks, contracts, and other instruments as may pertain to the ordinary course of the Company's business; and sign, when duly authorized thereto, all contracts, orders, deeds, liens, licenses, and other instruments of a special nature. He may also, in the absence or disability of the Treasurer, indorse checks, drafts, and other negotiable instruments for deposit or collection, and shall, with the Secretary, sign the minutes of all meetings over which he has presided. At the first regular meeting of the Board in January he shall submit a com- plete report of the operations of the Company for the preceding year, together with a statement of the Company's affairs as existing at the close of the last fiscal year, and shall submit a similar report at the annual meeting of stockholders; also he shall report to the Board of Directors, from time to time, all such matters coming within his notice and relating to the interests of the Company as should be brought to the attention of the Board. He shall be, ex officio, a member of all standing committees, shall have such usual powers of supervision and management as may pertain to the office of Presi- dent, and perform such other duties as may be properly required of him by the Board of Directors. SEC. 3. The Vice-President The Vice-President shall familarize himself with the affairs of the Company, and, in the absence, disability, or refusal to act of the President, shall possess all of the powers and perform all of the duties of that officer. SEC. 4. The Secretary The Secretary shall keep full minutes of all meetings of the stockholders and of the Board of Directors; shall read such minutes at the proper subsequent meetings; shall issue all calls for meetings and notify all officers and directors of their election; shall have charge of and keep the seal of the corporation, and affix the same to certificates of stock when such certificates are signed by the President and Treas- urer, and shall affix the seal, attested by his signature, to such other instruments as may require the same. He shall keep the stock certificate book and the other usual corporation books, and shall prepare, record, transfer, issue, seal, and cancel certificates of stock, as required by the transactions of the Company and its stockholders. He shall also sign with the President all contracts, deeds, licenses, and other instruments when so ordered. He shall make such reports to the Board of Directors as they may desire, and shall also prepare such reports and statements as are required by the State laws. He shall make out, twenty days before any election of Directors, a complete list of the stockholders entitled to vote at such election, arranged in alphabetical order, and giving the number of shares of stock that may be voted by each, and shall keep the same open to inspection at the office of the Company until the time of and during the said election. He shall allow any stockholder, on application in 1472 CORPORATE FORMS [Bk. IV- business hours, to inspect the stock certificate books, the stock transfer book, and the stock ledger. He shall attend to such correspondence and to such other duties as. may be incidental to his office or properly be assigned him by the Board. He shall receive such salary as may be fixed by the Board of Directors. SEC. 5. The Treasurer The Treasurer shall have the custody of and be responsible for all moneys and securities of the Company; shall keep full and accurate records and accounts in books belonging to the Company, showing the transactions of the Company, its accounts, liabilities, and financial condition; and shall see that all expenditures are duly authorized and are evidenced by proper receipts and vouchers. He shall deposit, in the name of the Company, in such depositary or depositaries as are approved by the Directors, all moneys that may come into, his hands for the Com- pany account. His books and accounts shall be open at all times during business hours to the inspection of any Director of the Company. The Treasurer shall also indorse for collection or deposit all bills, notes, checks, and other negotiable instruments of the Company; shall pay out money as may be necessary in the transactions of the Company, either by special or general direc- tion of the Board of Directors, and on checks signed by the President and himself, and shall generally, together with the President, have supervision of the finances of the Company. He shall also make a full report of the financial condition of the Company for the annual meeting of the stockholders, and shall make such other reports and statements as may be required of him by the Board of Directors or by the laws of the State. He shall give bond in the sum of Five Thousand Dollars, with sureties satis- factory to the Board of Directors, for the faithful performance of his duties and for the restoration to the Company, in event of his death, resignation, or removal from office, of all books, papers, vouchers, money, and other property belonging to the Company that may have come into his custody. He shall receive such compensa- tion as may be fixed by the Board of Directors. SEC. 6. The General Manager The General Manager shall, under the supervision of the Board of Directors and the President, have charge of and manage the active business operations of the Company. He shall perform such further duties and make such reports as may be required of him by the Board of Directors, and shall receive such salary, not exceed- ing Eight Thousand Dollars per annum, as may be fixed by the Board of Directors. ARTICLE V. DIVIDENDS AND FINANCES SEC. i. Dividends Dividends shall be declared at such times as the Board may direct, but no dividend shall be declared or paid save from surplus profits remaining after all current liabilities of the Company have been fully paid, nor shall any dividend be declared that will impair the capital of the Company. SEC. 2. Reserve Fund No dividend to exceed six per cent per annum shall be declared by the Board of Directors until there shall have been reserved from surplus profits a fund of not less than One Hundred Thousand Dollars, such fund to be designated "Exten- sion Fund" and to be used for the extension or enlargement of the business of the Company and the betterment of its plant, or for such other connected purposes as may be deemed necessary or advisable by the Board of Directors. SEC. 3. Bank Deposits The Treasurer shall deposit the moneys of the Company, as the same may come into his hands, in such depositary or depositaries as may be designated by the Ch. 3] BY-LAW FORMS 1473 Board of Directors, and such deposits shall be made in the name of the Company, and moneys shall be withdrawn therefrom only by check signed by the Treasurer and countersigned by the President. ARTICLE VI. SUNDRY PROVISIONS SEC. i. Corporate Seal The corporate seal of the Company shall consist of two concentric circles, between which shall be the name of the Company, and in the centre shall be in- scribed "Incorporated 1922, New Jersey," and such seal, as impressed on the mar- gin hereof, is hereby adopted as the corporate seal of the Company. SEC. 2. Penalties Any officer, director, or stockholder who shall disobey or violate any of the provisions of these by-laws shall be fined in an amount not to exceed Twenty Dollars, such fine to be imposed by the Board of Directors, and if not paid at the time, to be deducted from any salary or dividend then due or that may thereafter become due said person. SEC. 3. Amendment These by-laws may be amended, repealed, or altered, in whole or in part, at any regular meeting of the stockholders, or at any special meeting where such action has been duly announced in the call, provided that a majority of the entire voting stock of the Company shall vote for such amendment, repeal, or alteration. The Board of Directors shall have no power to amend, alter, or repeal the by-laws adopted by the stockholders, but may pass such additional by-laws in conformity therewith as may be necessary or convenient to facilitate the business of the Company. CHAPTER IV SUBSCRIPTION LISTS The subject of subscription lists and subscription contracts is treated very fully elsewhere. 1 No general discussion is there- fore attempted here. Form 67. Subscription List Simple Form SUBSCRIPTION LIST THE INTERLOCKING SWITCH COMPANY To be Incorporated under the Laws pf New York By JOHN H MILLS, HARVEY CHANDLER, AND THOMAS WILSON Capital Stock $100,000 Shares $100 each We, the undersigned, hereby severally subscribe for and agree to take at their par value the number of shares of the capital stock of the Interlocking Switch Company set opposite our respective signatures, said subscriptions to become due so soon as said Company is organized and to be then payable in cash on demand of the Treasurer of the Company. New York City, N. Y. May 21, 1922 NAMES ADDRESSES SHARES AMOUNTS Harry H. Collins 235 West 23rd St., N. Y. 10 $1,000 David B. White 975 Willis Ave., N. Y. 8 800 Willard H. Ellison Brooklyn, N. Y. 8 800 The names of the incorporators are brought into the heading of the foregoing subscription list and into that of the list that follows as a means of identifying more clearly the proposed cor- poration. When subscriptions are solicited widely or from parties at a 1 Book I, Ch. V, "Subscription Lists and Contracts." 1474 Ch. 4] SUBSCRIPTION LISTS 1475 distance, an individual subscription blank is usually employed and is mailed with such statements and prospectuses as may be necessary. The following is a common form: Form 68. Subscription Blank Individual THE CORD-TREAD TIRE COMPANY 175 Montgomery St. Jersey City, N. J. To be Incorporated under the Laws of New Jersey for the Manufacture of Automobile Tires By FRANK ALSTON, JOHN STONE, AND HOWARD COLE Capital Stock $500,000 Shares $10 each I hereby subscribe for shares of the capital stock of the Cord- Tread Tire Company at the par value thereof, and agree to pay Twenty-Five Per Cent (25%) of such subscription on demand of the Treasurer as soon as said Com- pany is incorporated, and Twenty-Five Per Cent (25%) on demand of the Treasurer of the Company at any time after ninety days from the incorporation of said Com- pany; the remainder of said subscription to be paid at such times and in such amounts, not exceeding ten per cent of said subscription in any one month, as may be required by the Board of Directors of said Company. Dated at The right is reserved to reject or prorate any or all subscription ; The reservation of the right to reject or prorate subscriptions enables the parties in control to exclude undesirable subscribers and also to scale or reject applications in case of oversub- scriptions. Stockholders of financial institutions in New York are liable for debts of the company to an amount equal to the par value of the stock of the institution owned by them. This double lia- bility is usually provided for at the time of organization by placing the price of shares at twice their par value, as in the fol- lowing application. This, when paid, creates a surplus equal in 1476 CORPORATE FORMS [Bk. IV- amount to the capital stock of the institution, and the stock- holders having already paid in twice the par value of their stock, are relieved of any further liability thereon. Form 69. Subscription to Bank Stock Individual SUBSCRIPTION FOR ,STOCK THE SECURITY NATIONAL BANK No. 57 Broadway, New York Capital, $1,000,000 Shares $100 each Surplus, $1,000,000 New York, 1922 The undersigned applies for shares of the Capital Stock of The Security National Bank of New York, at Two Hundred Dollars ($200) per share and agrees to accept such portion as may be allotted and pay for same when called. Place No. of Shares Date Name Address. . The foregoing blank was sent out accompanied by a list of the proposed directors and by the following letter : NEW YORK, March 26, 1922 Mr. JOHN EDWARDS, New York, N. Y. DEAR SIR: It is proposed to organize a National Bank with One Million Dollars ($ 1,000,- ooo) Capital, divided into Ten Thousand (10,000) Shares at One Hundred Dollars ($100) per share, and a surplus of a like amount. The offices of the bank will be located at No. 57 Broadway, New York City. Upwards of One Million, Five Hundred Thousand Dollars ($1,500,000) have already been subscribed towards the proposed organization and the gentlemen named on the opposite page will act as Directors. A form of subscription is herewith enclosed and you are invited to become a subscriber to the capital stock. Subscribers are requested to forward their subscriptions to the undersigned at the above address. Truly yours, WILLIS S. PARKER, Chairman of Organization Committee N.B. Subscription books will close on May first. Subscriptions made under the terms of the foregoing list or application are of the nature of a continuing proposition, and. Ch. 4] SUBSCRIPTION LISTS 1477 until the company is organized and has actually accepted them, are revocable at the will of the subscribers. 2 To avoid this ele- ment of uncertainty, subscription lists are sometimes drawn as in the following form, with a trustee acting for the corporation. Form 70. Subscription List Trustee's SUBSCRIPTION LIST WARREN CEMENT COMPANY 215 Broad St., Newark, N. J. To be Incorporated under the Laws of the State of New Jersey for the Manufacture of Portland Cement Capital Stock $1,000,000 Shares $100 each We, the undersigned, hereby agree with James J. McLaren as Trustee for the Warren Cement Company, to subscribe, and do hereby severally subscribe, for the number of shares of the capital stock of said Company set opposite our respective signatures, and agree to pay the par value thereof as follows: Ten Per Cent do%) on demand to James J. McLaren as Trustee for said Company, such payment, or so much thereof as may be necessary, to be used for the preliminary and incorporating expenses of said Company; Thirty Per Cent (3%) to the Treasurer of the Company so soon as said corporation is organized; Twenty-Five Per Cent (25%) on demand of the Treasurer of the Company at any time after ninety days from the date of incorporation; and the remainder at such times and in such instalments as may be prescribed by the Board of Directors. Newark, New Jersey, March 15, 1922 NAMES Mr. Alfred H. Braum James H. Allen William Raymond ADDRESSES Paterson, N. Y. 25 Wall St., N. Y. Brooklyn, N. Y. SHARES 5 75 5 AMOUNTS $5, coo 7,500 5,000 Subscriptions under the preceding form are held to be a con- tract between the subscribers and the trustee. They cannot therefore be withdrawn nor revoked but are binding from the date when made. The subscription list which follows is of a similar nature. 'See Book I, 55 47. 48. 1478 CORPORATE FORMS [Bk. IV- Form 71. Subscription List Agreement with Promoters SUBSCRIPTION LIST HARRISON COTTON MILLS Capital Stock $500,00x3 Shares $100 each We, the undersigned, hereby agree with William H. Hamilton and John B. Ravvley, both of New York City, New York, as Promoters and Trustees of the Harrison Cotton Mills, a corporation to be organized under the laws of the State of North Carolina for the purposes and under the conditions set forth in the attached statement, to subscribe, and do hereby severally subscribe for the number of shares of the Treasury Stock of said Company set opposite our respective signatures at the rate of Seventy-five Dollars ($75) for each One Hundred Dollar share, and agree to pay the amounts of our respective subscriptions to the Treasurer of the Harrison Cotton Mills as soon as the said Company is incorporated and its treasury stock ready for issue; said stock to be delivered to the respective subscribers therefor full-paid and non-assessable upon payment of the said subscription price. It is mutually agreed between the subscribers hereto and the said William H. Hamilton and John B. Rawley, Promoters and Trustees of said proposed corpora- tion, that the subscriptions of this present contract are conditioned upon bona fide subscriptions for stock to the par value of Three Hundred Thousand Dollars ($300,000) being secured hereunder within ninety days from the date hereof, and otherwise are null and void. New York City, New York, January 18, 1922 NAMES ADDRESSES SHARES AMOUNTS Samuel H. French Raleigh, N. C. 50 $3,750 Charles H. Wellbourne Raleigh, N. C. 50 3.75Q H.G.Williamson New York City, N. Y. 100 7,500 Such a subscription list is usually circulated with a statement attached giving full details as to the capitalization and purposes of the company. When signed it forms an irrevocable contract between the subscribers and the trustees. This subscription contract requires the delivery of full-paid treasury stock, notwithstanding the fact that the subscription price amounts to but 75% of its face value. This is usually accomplished by the issuance of the stock for property and the return of a portion of this issued stock to the company to be sold for operating capital. Full-paid treasury stock is thus secured to fill the contract requirements. 8 See Book I, { 125. CHAPTER V SUBSCRIPTION RECEIPTS AND RECORDS After incorporation, payments of stock subscriptions are made to the treasurer of the company and receipts are issued by him. If payments are to be made before incorporation, a trustee or trustees must necessarily be appointed to act for the company. Such trustees are usually selected by those having charge of the subscription and are named in the subscription list as shown in Forms 70 and 71 and thereby made parties to the transaction. Form 72. Trustee's Receipt No. 56 15 Shares LANSFORD MANUFACTURING CORPORATION TRUSTEE'S CERTIFICATE $150.00 I hereby certify that Henry M. McGill, a subscriber for Fifteen Shares of the Capital Stock of the Lansford Manufacturing Corporation at its par value of One Hundred Dollars per share, has paid to me as Trustee for said Corporation, on account of said subscription and in accordance with its terms, the sum of One Hun- dred and Fifty Dollars. This receipt will, upon the organization of the said Lansford Manufacturing Corporation, be received and credited by the Treasurer thereof to its full amount as a payment upon said subscription. New York, GERALD H. McNELL, February 20, 1922 Trustee Receipts of this nature are usually printed and bound in book form with stub attached, and are so perforated that the receipt may be easily torn out and given to the party making the pay- ment. The stub is the trustee's record of the transaction. It should show the number of the receipt, the amount paid in, the name of the payee, the number of shares subscribed for, 1480 CORPORATE FORMS [Bk. IV- the percentage or other details of the instalment, and the date. When instalments are paid after incorporation, a treasurer's receipt may be given for each payment. The following is a simple form: Form 73. Treasurer's Receipt for Instalment HO No. 34 15 Shares THE WILCOX RADIATOR COMPANY 30 Broad Street New York $150.00 Received of Edward H. Williamson the sum of One Hundred Dol- lars, instalment payment No. 5, of Ten Per Cent upon his subscription for Fifteen Shares of the Capital Stock of The Wilcox Radiator Company. New York City, * J. H. WILCOX, April 14, 1922 Treasurer This receipt should also have its stub upon which the im- portant items are entered. When payment is made in full of a stock subscription, and the stock certificates are ready for delivery, they are in them- selves a sufficient receipt. If not ready for delivery, temporary certificates are frequently issued and are exchanged for the permanent certificates of the company as soon as the latter are ready for delivery. These temporary certificates are in the form of the regular stock certificate, but are usually prepared at no greater expense than is justified by their temporary nature. In some cases, however, the temporary certificate is a hand- somely engraved instrument fully equal in appearance to the usual permanent certificate. When permanent stock certificates are not ready for deliv- ery at the time payments are made, and temporary certificates are either not ready or are not to be issued at all, the treasurer's receipt can be used to bridge over the interim, and in such case is usually more formal than the ordinary receipt. The treas- urer's receipt which follows is of this nature; it is usually in- tended for very temporary use and is then severely plain in style. Ch. 5] SUBSCRIPTION RECEIPTS AND RECORDS 1481 Form 74. Treasurer's Receipt for Stock Subscription ; No. 50 10 Shares HOWARD PUBLISHING COMPANY No. 225 Atlantic Avenue, Brooklyn, N. Y. H 04 : w : $1,000.00 This is to certify that Harry H. Wilson has paid into the Treasury of the Howard Publishing Company the sum of One Thousand Dollars, payment in full of his subscription for Ten Shares of its Capital Stock, duly executed Certificates for which will, upon surrender of this Receipt, H be issued to his order so soon as said Certificates are ready for delivery. ! March 3, 1922 FRANK J. ARDWALD, Treasurer At times when payment of stock subscriptions has been made and neither permanent nor temporary certificates are ready for delivery, the president will join the treasurer in the signature of the foregoing treasurer's receipt, which then becomes in effect a stock scrip. The usual form of stock scrip is, however, as shown in Form 75. This scrip might or might not be sealed. Ordinarily the corporate seal is affixed and the stock scrip then becomes for all practical purposes a temporary stock certificate. Stock scrip is sometimes employed when subscription pay- ments are made in instalments. The face of the scrip evidences the first instalment, and subsequent instalments are either indorsed on the back of the scrip, the treasurer's signature verifying each payment, as shown in Form 76, or, if personal payment is impossible, are evidenced by separate receipts. In such case each receipt will of course "tie up" closely with the scrip so that the two are easily corrected. When the indorsement plan is followed, the stub should also have rulings to permit the entry of payments and their date, so that both the scrip and its stub will show a complete record of the transaction. \ 1482 CORPORATE FORMS [Bk. IV- y a -C T3 IJ 'S '" "S 3 'g '3 *J "> > "" o ^ o D 4> b M tn^a. rt^ 5S Ki r^ crt (/I 'T? ^j J5 ^ ^il) (jiC 2i S^di"" rt '" ^s O 2^5 -2 ^ S M H ElS-3 g-o^ W < *" ^ -S '5 '*3 iJ ! cj 2: & 2 4- T-) .& 3 ^ W I O *< "3 U StuSS^M PH W M u llll Illfffl u r^ O r/1 ^ "" "^ r^ C t I [TJ t tn g-'3 nl ' iS, * INSTALMENT CERTI] LANSFORD MANUFACTURIN 156 Liberty Stre New York i is TO CERTIFY, that Henry H. McGill, a Stock of the Lansford Manufacturing Co ic of One Hundred Dollars per share, has t ly on account of said subscription and in i Hundred and Fifty Dollars. n payment of the remaining instalments of is thereof, and surrender of this Certificate Shares of stock will be issued to the order oi less our official signatures this i4th day of . WILLIAM H. HANSFORD, Treasurer J 3l3 a^J-S gg 3 * \ j 4s 10 . * 1 s b M uT < |! Of P ^ *tn o 52 5 o re *2J fc rt c -a -o 43 H ^^ o rN, G ! ~~ O g C " ~ X o ^ "'"^ C3 - o 8 a ^eu r^ 5 |j| % 1 & > u J bH 11 D !C ^^ 42 SI in ., r \ -* Incorporated under the The State of New J THE FRANCONIA NURSEI Capital Stock. Common Stock Preferred Stock m cjl 1 G .-2 i 1 ERTIFY that Roger P. Sherman tock of The Franconia Nursery ( mpany by the said owner ther pon surrender of this Certificate Witness the Seal of the ( duly authorized offic JISONS, easurer Shares, $100 eac *S J r? y^ 3 . <, K. x ^ , O ,T PU hs CO 1 p. w ^ S 43 3 5 * ' C P 1 H* " d r^ ^, w 1^ en ^ o *j S en "^ u to " u en e8 c I 6 H 0-2 O ^ " ~ ' O CJ Z "o 42 .~ 1 a b -i "5 "o ^ fc ^ > u . rt **- c?"O H 2 W 5 < 5 l/> ' . M H , a f-< w pi O - > ! il; ? s| (N C o g 8 is p< J7 "w g^ T3 U > 4J >-i i- 3 "cd ^ ClJ 4) t"^ ^ O o Q p< Ch. 6] STOCK CERTIFICATES 1487 Certificates for shares of no par value differ but little in form from the common stock certificate shown in Form 78. As the shares have no par value the total capital stock of the company cannot be given. The certificate, however, as shown in Form 79, usually states the number of shares of no par value and, if there is preferred stock with a stated par value, the number of its shares with the par value of each. Form 79. Stock Certificate No-Par-Value Shares No. 35 100 Shares Incorporated under the Laws of the State of Delaware KINSEY-MORGAN MOTORS COMPANY r * T Cf i /Common Stock, 10,000 shares without nominal or par value ck \Preferred Stock, 1,000 shares of $100 each Full-Paid and Non-Assessable THIS is TO CERTIFY that Henry P. Williams is the owner of One Hundred Shares of the no-par-value Common Stock of the Kinsey-Morgan Motors Company, transferable on the books of the Company by the owner thereof in person or by duly authorized attorney, upon surrender of this certificate properly indorsed. (CORPORATE! Witness the Seal of the Company and the signatures of its \ SEAL / duly authorized officers this tenth day of January, 1922. HOWARD McALPiN, President FRANK W. KINSEY Treasurer When certificates for preferred stock are prepared, the con- ditions of issue should be set out in full on the face of the cer- tificate, though, if lengthy, the certificate may merely embody the more important provisions, and reference be made on the certificate to the charter, the by-law, or the resolution under which the stock is issued. When a reference of this kind is to be made, the wording of Form 80 would be followed to the end of the first paragraph. The next paragraph would then read as follows: "The preferred 1488 CORPORATE FORMS [Bk. IV- M to o s 4) S-i I d P i ggs^ll^ d a d x|cjo 0) o to fi " *3 QJ <-> O P > 5 ^ z '2^ b >. S ^ W S 2-g "5 g ii 3I 2 8 o t! u a c J S 'p H u Ch. 6] STOCK CERTIFICATES 1489 stock represented by this certificate is authorized by the Certif- icate of Incorporation of the said Company as filed in the office of the Secretary of State of New York on the first day of May, 1922, and is issued under the terms and conditions therein set forth." In some few states the statutes prescribe that the condi- tions of preferred stock must appear with greater or less ful- ness on the face of the certificate. Preferred stock is sometimes issued in very crude form, "Preferred Stock" being printed across the face of the ordinary certificate in red or some other distinctive color or style, fol- lowed by the conditions under which the preferred stock is issued. Preferred stock certificates are numbered independently of the common stock certificates. That is, the first certificate of preferred stock is numbered "i" regardless of the fact that the first certificate of common stock is also numbered "i," the two series being sufficiently distinguished by the fact that they are respectively common and preferred stock. Stock is transferred by assignment, the form being printed upon the back of the certificate. There is but one form of this assignment in common use, which, though informal and incom- plete in some respects, is almost invariably employed. When this assignment is executed by the owner of record, and the certif- icate is duly delivered, the stock represented thereby becomes the property of the party named in the assignment form. If this party wishes to assign the certificate again, he might execute another similar assignment, either written on the back of the certificate, or prepared as a separate document and attached to the certificate. More commonly he surrenders the certificate and takes out a new one in his own name, or in the name of the party to whom he wishes the stock to be transferred. Or a very common practice when stock is assigned the assignment is duly executed, but the blanks for the names of the assignee and the attorney are not filled in at all. The I4QO CORPORATE FORMS [Bk. IV- certificate is then said to be "assigned in blank" and may be passed from hand to hand without further formality, the equi- table ownership of the stock following the certificate. Any owner who wishes to make himself a stockholder of record, i.e., appear upon the stock books of the company as the owner of the stock, may then fill out the blanks in the assignment, turn the cer- tificate in to the secretary of the company for cancellation, and receive a new certificate in his own name. 2 The following assignment is complete, the parts which have been filled in being indicated by parentheses : Form 81. Assignment of Stock Certificate For Value Received, (I) hereby sell and transfer unto (John J. McMillan of New York City, Twenty-five) Shares of the Capital Stock represented by the within Certificate, and do hereby irrevocably constitute and appoint (Harry S. Gunnison) my attorney to transfer the said stock on the books of the within named Company with full power of substitution in the premises. Dated (March 2, 1922) (HOWARD S. ALLEN) In presence of (ANNA H. MARSHALL) Usually the secretary of the company is designated as the attorney who is to make the transfer on the books of the com- pany, though any other suitable person might be named instead. Sometimes stock is held by trustees under the terms of -a voting trust agreement. 3 In such case, at the time the trust is formed the certificates of stock to be held under it are duly assigned and are turned in to the trustees, who surrender them for cancellation and take out certificates in their own names as voting trustees. Voting trustees' certificates are then usually prepared in the general style of the ordinary stock certificate, and are de- livered to the parties to whom the stock belongs to evidence ' See Book I, Chs. XXXVIII and XXXIX, "Transfers of Stock." 1 For text of a voting trust agreement, see Form 104. Ch. 6] STOCK CERTIFICATES 1491 its real ownership. These trustees' certificates pass by assign- ment, the equitable ownership of the stock being thereby vest- ed in the assignee. Forms 82 and 83 give the general wording of a voting trustees' certificate. Form 82. Voting Trustees' Certificate Organized under the Laws of the State of New York Number 125 35 Shares ALBANY PAPER COMPANY Capital Stock, $750,000 CERTIFICATE FOR STOCK DEPOSITED UNDER VOTING TRUST AGREEMENT OF APRIL 12, 1922 The undersigned Trustees, by the National Trust Company, their agent, hav- ing received on deposit the entire capital stock of the Albany Paper Company, full- paid and non-assessable, all being held under the above-named agreement, to the terms of which the holder hereof assents by receiving this certificate, certify that John N. Allen is entitled, subject to the provisions of said agreement, to Thirty-five Shares of the stock deposited thereunder. This Certificate entitles the holder to all rights, dividends, and privileges belonging to the actual stock, excepting only the right to vote. The Trusteeship herein agreed to may be terminated after three years upon the terms set forth in the above-named agreement, and is ended by limitation in ten years from date of agreement. Transferable only on the books of the undersigned at the office of the National Trust Company, New York City, by the holder hereof in person or by duly author- ized attorney, upon surrender of this certificate properly indorsed. Dated April 15, 1922 HENRY W. TURNER, FRANK D. McCALL, WILLIAM H. MONTGOMERY, HOWARD F. BERGMAN, PHILIP T. ATWATER, Trustees By NATIONAL TRUST COMPANY, Depositary and Agent By HOWARD T. LATHAM, Secretary When the voting trust is terminated, these trustees' certif- icates are exchanged for the usual stock certificates. 4 4 See Book I, Ch. LVI, for discussion of voting trusts, and Form 104, for voting trust agreement. 1492 CORPORATE FORMS [Bk. IV- A simpler form of trustees' certificate is as follows: Form 83. Voting Trustees' Certificate Simple Form Number 65 25 Shares HANDSEL CHROME OXIDE COMPANY TRUSTEES' CERTIFICATE OF BENEFICIAL INTEREST The undersigned, as Trustees under a certain Trust Agreement entered into between themselves and John H. Baldwin on the seventh day of December, 1921, whereby the entire Capital Stock of the Handsel Chrome Oxide Company has been placed in their hands subject to the terms of said agreement, do hereby certify that Henry P. Bowman is the owner of Twenty-five Shares of the beneficial interest set forth in said agreement. Transferable only on the books of the Trustees in person or by attorney, and upon the surrender of this certificate duly indorsed. IN WITNESS WHEREOF, the Trustees have signed this certificate this 15th day of January, 1922. HOWARD COLEMAN ] JOHN W. WILLARD > Trustees SARGENT P. CUMMINGS I The form of assignment on the back of either of these certif- icates would be in the following general form: Form 84. Assignment of Voting Trustees' Certificate For Value Received, I hereby sell, assign, and transfer to Charles Campbell the interest in the stock of the Albany Paper Company represented by the within Certificate, and do hereby irrevocably constitute and appoint Howard T. Latham my attorney to transfer the said interest on the books of the within-named Trus- tees, with full powers of substitution in the premises. Dated June 15, 1922 JOHN N. ALLEN ;;.;;;; CHAPTER vii STOCK BOOKS The usual stock books are the transfer book and the stock ledger, this latter being also frequently referred to as the stock book.i Form 85. Stock Transfer Book Ledger Folio 27 Transfer No. 556 ALLIANCE MOTOR COMPANY For Value Received, I hereby sell, assign and transfer unto John H. Lansing, of Newark, New Jersey, Seventy-six Shares of the Capital Stock of the above- mentioned Company, now standing in my name on the Company books and repre- sented by surrendered Certificates Nos. 32, 37, and 44. Witness my hand and seal this 28th day of May, 1922. GEORGE B. GOLDMAN [L. s.] By GEORGE GALE, Attorney New Certificate No. 224 Issued to John H. Lansing Ledger Folio 84 1 ~ The transfer, books supplied by stationers usually have a stub attached to the transfer. As the transfer itself remains in the book, this stub is merely an unnecessary repetition of matter already shown on the transfer. The transfer book itself is practically a duplication of the assignment appearing upon the stock certificate, and by many corporations is not kept at all, the duly executed assignment on the back of the certificate being regarded as an all-sufficient authorization for the transfer of the assigned stock. 5 > For discussion of the stock books, see Book I, 262, and Ch. XXXVII, "The Stock Records"; also Book III, 55 3 8 -4?- F r form of stock register and transfer register, see Ch. XXVI, "Miscellaneous Books of Record." 1493 1494 CORPORATE FORMS [Bk. IV- The signature to the assignment of the stock transfer book is sometimes witnessed. This signature is, however, usually that of the secretary or the transfer agent, or is affixed in their presence, and as the assignment is at the most but supple- mentary to the duly witnessed assignment on the back of the surrendered certificate, a witness to its signature is gen- erally regarded as superfluous. In many states a stock book or stock ledger the two being practically synonymous is required by the statutes. Whether required by the statutes or not, some book of the kind must necessarily be kept in order to provide an accurate record of the issued and outstanding stock of the company. The form of stock book or stock ledger shown in Form 86 will be found con- venient and will meet the statutory requirements of almost every state. The leaves of this book are indexed, usually as a matter of convenience, but in some states to secure the alphabetical arrangement required by statute. The name and address of the stockholder with whom the particular account is kept appears at the head of the page as in an ordinary ledger. On the right-hand side of the page the party is credited with the stock he purchases or otherwise acquires, and on the left-hand side is debited with any stock sold or otherwise disposed of. The difference between the two sides shows at any time the amount of stock standing to his credit. On the debit or sale side of the account, the first column gives the date of the transaction; the second the name of the party to whom the stock is transferred; the third the number of the surrendered certificate; the fourth the number of the certificate reissued to the transferrer when but a portion of the stock represented by the surrendered certificate is sold; and the fifth column shows the number of shares sold. On the credit side, which shows stock acquired by the party with whom the account is kept, the first column gives the date of purchase; the second the name of the party as- STOCK BOOKS M G I w & B CO B s a I 8 I O to m o O in 1/5 o ^ t- fO 1/5 O "1" Ot OC M PO M 1 i in bug H H m Bl < S 1? M "2 '* BaS S < X r2 'cj 3 FROM WHOM SHARES WERE TRANSFERRED u 8 "g g "3 1 1 & 3 1 I i- 1 ri i I 1 J 1 1! 1 l ll to O in M in M in M M N M M >> > > IS o o > M rf ^- N O 00 O MM fO M H in .52 < (U t^ -l- t- ro ai5 , l/> O 1/5 1/5 !/5 /5 M t^ Tt 00 -^2 To WHOM SHARES ARE TRANSFERRED 1 i ; 1 1 . ja p O O *-< *- 4J 5 JB " g g ffi t ^ ^ < ^2 N Jgi ' I nl g | pJ p^ ffi -, i , id SS Hi PO ^5 H ro O M _ M M PO M CO S jj x x y J S ^ ^, CM Q Q 1496 CORPORATE FORMS [Bk. IV- 3 ^ t/1 5 Id r B"' Sog s O 1 o Id H 3 5 N il;il 2 s w to ^ U 1 V) g WD^P CAlg; K Ed .2 'ft CO < 10 CO co 1 Id | 1 | o O 'a ^ 8 O Q U .. 2 3 U o Tt 1 1 & % g 'Z o . W ^ 2 ^ RCHASER FEREE || J2 < 'C R ^ H CO P cu -i V< < A gl NAME OF Pi OR TRANS ^ a: a e s 1 U w p P=H a |S 1 Id U ft, Id p 3 > ta aj a s {2 S K^ . i 1 en 1 > fe s u \ T UMBER SHARES 1 3 & s M & 5- ^ t^ ^> Jl u 2 w ME OF STOCK M u 5 CO w S b S 2 report to the Secretary of State is omitted as being purely local. New Jersey corporations may obtain the necessary blanks by application to the Secretary of State at Trenton, New Jersey. Form 95. Call and Waiver Directors' THE BARSTOW MOTOR CORPORATION CALL AND WAIVER OF NOTICE FOR FIRST MEETING OF DIRECTORS We, the undersigned, being all of the Directors of The Barstow Motor Corpo- ration, do hereby call the first meeting of the Directors of said Company to be held in the office of George H. Madison, No. 845 Broad Street, Newark, New Jersey, at 4 P.M., on the sth day of January, 1922, for the purpose of electing officers, acting upon a proposal to assign property to the Company in exchange for stock, and for doing ail such other things as may be necessary or desirable in connection with the organization of the Company or the promotion of its business, and we hereby waive all statutory or by-law requirements as to notice of time, place, and objects of said meeting and consent to the transaction thereat of any and all business pertaining to the affairs of the Company. Newark, New Jersey, January 5, 1922 FRANK HARRIS GEORGE H. BARSTOW HOWARD MILLIKEN SARGENT DAVIS WILSON P. NOBLE HARVEY CRAWFORD 1508 CORPORATE FORMS [Bk. IV- Frequently when directors' meetings are to be assembled by call and waiver, the signatures of all the directors are not secured at the time but are secured subsequently and some- times long after the date of the meeting. It is worthy of note that it has been held that a director's signature to a waiver after the meeting "looking to ratification of what was done is without force to validate the action taken." 2 In this case the action of a meeting held pursuant to a waiver which was not signed by some of the directors until after the meeting, was held to be invalid. Form 96. Secretary's Oath of Office SECRETARY'S OATH STATE OF NEW JERSEY COUNTY OF ESSEX Sargent Davis, the Secretary of The Barstow Motor Corporation, being by me duly sworn, upon his oath, does promise and swear that he will faithfully and impartially discharge the duties of Secretary of said Company to the best of his skill and ability. SARGENT DAVIS Subscribed and sworn to before me this 5th day of January, 1922. FRANK B. ESMOND, Commissioner of Deeds for the State of New Jersey The New Jersey statutes require that the secretary be sworn. It would seem to be a somewhat empty formality. Form 97. Proposal to Exchange Property for Stock PROPOSAL TO EXCHANGE PROPERTY FOR STOCK To THE BARSTOW MOTOR CORPORATION, 845 Broad Street, Newark, New Jersey GENTLEMEN: I hereby offer in exchange and full payment for the Common Stock of your Company, amounting to Two Thousand (2,000) Shares of the par value of One Hol"ombe el al. v. Trenton White City Co.. 82 Atl. (N. J.) 618 Ch. 9] DIRECTORS' ORGANIZATION MEETING 1509 Hundred Dollars ($100) per share, United States Letters Patents Numbers 605,949 and 605,950, issued to me October 7, 1921, for Improvements in Internal Combus- tion Motors, said Patents to be assigned to your Company together with my agreement to assign without further consideration all other inventions and im- provements in Internal Combustion Motors which I may at any time hereafter make, own or control. If this proposition is accepted, the said Two Thousand (3,000) Shares of Stock are to be issued to my order, full-paid and non-assessable, against the delivery to your Company of due assignments of said Letters Patent and of my duly executed agreement for the assignment of any future inventions and improvements that I may make in Internal Combustion Motors. Yours truly, GEORGE P. WILLIS New York City, January 5, 1922 This proposal provides for the issue of the entire common stock in exchange for the property mentioned. The incor- porators have already subscribed for at least a portion of the common stock of the company. On the face of it, therefore, the proposal calls for the issue of stock already under contract to the incorporators and this must be adjusted in some way be- fore the proposal is accepted. The matter may be easily ar- ranged in either one of two ways: by agreement with the party making the proposal, that his payment as far as the incor- porators' subscriptions are concerned may be regarded as paid on their account, the stock being issued to them; or the incorporators may assign their subscriptions to the party making the proposal. If this latter plan is the one adopted, the following form will apply: Form 98. Assignment of Subscriptions ASSIGNMENT OF SUBSCRIPTIONS We, the undersigned, all the subscribers to the Common Stock of the Barstow Motor Corporation, for and in consideration of the sum of One Dollar to each of us in hand paid, and of other good and valuable considerations, the receipt of which is hereby acknowledged, do hereby respectively sell, assign, and make over to George P. Willis all our subscription rights to the Stock of said Company: It is understood, however, that this assignment is conditioned upon the acceptance by said Company of the proposal of this date of said George P. Willis to purchase the entire Common Stock of said Company, and is to go into effect only 1 5 io CORPORATE FORMS [Bk. IV- upon due tender by him of payment for said Common Stock in accordance with the terms of the said proposal. Witness our hands and seals this fifth day of January, 1922. GEORGE H. BARSTOW HOWARD MILLIKEN SARGENT DAVIS WILSON P. NOBLE FRANK HARRIS The directors' minutes on a preceding page give a form of resolution for designating the corporate depositary. This form is simple but sufficient for all practical purposes. In many cases, however, the banks have their own forms of desig- nating resolution which they prefer and in some cases insist upon. These forms are for the most part unobjectionable, but in some cases will be found to confer excessive powers upon the officers of the corporation. If this is not desired, any such resolution may be so modified as to eliminate the undesirable features while still preserving the general form preferred by the bank. The banks usually require the resolution designating the corporate depositary to be certified. Such certification is best made by the secretary of the company and may be as shown in Forms 224 and 225. Under some circumstances it is impossible to secure the signatures of all the directors to a call and waiver. In such case, if by-laws have been adopted by the stockholders and the first regular meetings of directors under these is near at hand, the business of the first meeting may be postponed until this regular meeting. Usually, however, a more immediate meet- ing is necessary, and in such case it must be assembled by means of a call. In the absence of any conflicting provisions in the by-laws, such call signed by a majority of the board of directors will be effective. The following form may be used. Under ordinary conditions the period between the send- ing of notice and the time of meeting must be sufficient to allow every member of the board to receive the notice and be Ch. 9] DIRECTORS' ORGANIZATION MEETING 1511 present at the meeting. Any by-law provisions as to the num- ber of days to elapse between the notice of the special meet- ing and the special meeting held pursuant thereto, should be observed. Form 99. Call for First Directors' Meeting CALL FOR FIRST MEETING OF DIRECTORS of the MIDVALE COAL COMPANY We, the undersigned, Directors of the Midvale Coal Company, hereby call the first meeting of the Directors of said Company to be held in the office of John H. Welch, 229 Broadway, New York City, New York, at 3 P.M. on the 3rd day of January, 1922, for the purpose of electing officers, acting upon a proposal to assign property to the Company in exchange for stock, and doing all such other things as may be necessary or desirable in connection with the organization of the Company and the promotion of its business. New York City, THOMAS L. SHERMAN December 30, 1921. DANIEL T. BROWN JOHN H. WELCH CHAPTER X OPTIONS AND VOTING TRUST AGREEMENTS OPTION AGREEMENTS When a corporation is to be formed for the purpose of purchasing or taking over certain properties, option contracts are usually employed to hold these properties until the cor- poration can be organized and act for itself. Such contracts, even though made by trustees for the corporation, are not binding upon the corporation until accepted or ratified by its formal action. In drawing such contracts, therefore, care should be taken that the parties acting for the corporation are not individually bound or involved by the contract terms unless this is intended. Form 100. Option on Capital Stock OPTION AGREEMENT An Agreement made and entered into this i4th day of May, 1922, by and between John H. Wyckoff of Philadelphia, Pennsylvania, party of the first part, and George Andrew Dennison of New York City, party of the second part: WHEREAS, The said John H. Wyckoff owns or controls the capital stock of the Wyckoff Publishing Company, a corporation duly organized under the laws of Delaware and carrying on its business in the City of Philadelphia, said business being the publication of "The Household," a monthly magazine owned by the said Wyckoff Publishing Company; and WHEREAS, The said George Andrew Dennison owns or controls a monthly magazine known as "Home Topics" and desires to purchase and combine there- with "The Household," and to form a corporation to own and publish the maga- zines so combined; Now, THEREFORE, In consideration of the sum of Two Hundred and Fifty Dollars ($250) paid the said Wyckoff by the said Dennison, the receipt whereof is hereby acknowledged, the said Wyckoff for himself and his associates agrees to sell to said party of the second part or his assigns, at any time on or before the ist day of July, 1922, all and singular the entire right, title, and interest in and to 1512 Ch. 10] OPTION AGREEMENTS 1513 the said monthly magazine, including subscription lists, advertising contracts, good-will, and all things incident to or pertaining to said magazine and its publica- tion; or at the option of said party of the second part, the entire capital stock of the aforementioned Wyckoff Publishing Company, consisting of Four Hundred (400) Shares of Common Stock of the par value of Forty Thousand Dollars ($40,- ooo); the consideration for the transfer and assignment of said magazine, or said capital stock, to be Twenty Thousand Dollars ($20,000) in cash and one-fourth of the capitalization of the corporation formed to take over said publication. This option shall expire and be of no further force or effect after the ist day of July, 1922, unless on or before that date said Dennison or his assigns shall deposit with the Guaranty Trust Company of 140 Broadway, New York City, said sum of Twenty Thousand Dollars ($20,000) in cash, together with certificates issued in the name of John H. Wyckoff, for one-fourth of the entire capital stock of said new corporation, said cash and stock to be held in escrow by the said Guaranty Trust Company and to be released and delivered to the said Wyckoff upon the delivery to said Trust Company of a duly executed and valid assignment of said magazine to said new corporation, or otherwise of the entire duly assigned stock of the Wyckoff Publishing Company, as may be required by the written demand of the said Dennison or his assigns, as hereinafter set forth. So soon as said cash and stock of the said new company are deposited in escrow as aforeprovided with the Guaranty Trust Company, said Dennison or his assigns shall give said Wyckoff written notice thereof and shall specify therein whether said Dennison desires the assignment of said magazine, or the stock of the said Wyckoff Publishing Company in exchange for the said escrowed cash and stock, and said Dennison shall at the same time file a signed copy of said notice with the Guaranty Trust Company. It is understood and agreed that should the sale contemplated by this present agreement fail, neither party hereto shall be liable in any way under or by reason of this present agreement, and that should this option be assigned to any other person or to any corporation, the said Dennison shall be free from all liability thereunder. IN WITNESS WHEREOF, the said John H. Wyckoff and the said George Andrew Dennison have hereunto affixed their respective signatures and seals the day and year first above written. JOHN H. WYCKOFF [L. s.] GEORGE ANDREW DENNISON [L. s.j Attest signatures: MARY M. WESTCOTT WILLIS BENNETT In this option no provision is made for any change during the option period in the value of the property involved. In the option which follows, such changes are guarded against by means of the provision that the price is to be the appraised value at the time of purchase plus a definite amount for good- will. In drawing up an option, care should be taken always to express the fact that the price paid for the option is to be deducted from the total consideration. There should be no ambiguity in regard to this feature. 1514 CORPORATE FORMS [Bk. IV- Form 101. Option on Business and Property OPTION AGREEMENT An Agreement entered into this 25th day of June, 1922, by and between the Oswego Hub and Spoke Company, a corporation duly organized under the laws of the State of New York, party of the first part, and Willis P. Emerson of New York City, party of the second part. For and in consideration of the sum of One Dollar paid said party of the first part by the party of the second part, receipt whereof is hereby acknowledged, and for other good and valuable considerations, said party of the first part does hereby agree to sell to said party of the second part, as a going concern, its entire business, factories, and plant for the manufacture and sale of hubs and spokes, owned and operated by said party of the first part in the City and County of Oswego, State of New York, including therewith all machinery, tools, and other property and appurtenances thereunto belonging, together with all raw materials and manu- factured products on hand, and all contracts relating to the purchase or sale of such materials and products; also the good-will of said business and all trade- marks, brands, patent rights, licenses, and shop rights used theYein and controlled by said party of the ru^t part; excepting only moneys and bills and accounts receivable on hand at the time of sale; all of said property to be delivered free and clear from all liens, charges, encumbrances, taxes, and assessments, save and ex- cept for a certain mortgage upon the real property of the party of the first part, amounting to Thirty Thousand Dollars ($30,000) and now on record in the office of the County Clerk of Oswego County. The price to be paid for said property shall be an amount Twenty Thousand Dollars ($20,000) in excess of the actual appraised value, at the time of purchase, of said real and personal property, exclusive of good-will, as above set forth, and such amount shall be paid in cash at the time of transfer, the aforementioned mort- gage being assumed by the purchaser and accounted as a cash payment to the amount of said sum of Thirty Thousand Dollars ($30,000) and accrued interest thereon due at the time. This option shall expire and be of no further effect on and after the 3ist day of July, 1922, unless prior thereto said party of the second part, or his assigns shall, in writing, notify said party of the first part of his or their intention to exer- cise the same, and shall at that time deposit in the Oswego National Bank, Ten Thousand Dollars ($10,000) in cash as a guaranty of good faith and to apply upon the purchase of said property, and in such event the party of the first part shall within sixty days of such notice and deposit, transfer and convey said business and property by such deeds, conveyances, and assignments and other instruments as may be necessary to vest the full right, title, and interest in said business and property in said party of the second part or his assigns. It is further understood and agreed that said party of the second part assumes no responsibility to purchase said property unless he or his assigns shall elect so to do by written notice and deposit in bank as aforeprovided, and that in case of assignment of this present instrument by said party of the second part, all its pro- visions shall inure to the benefit of, and run in favor of, and be binding upon his assignee or assignees in every respect as theretofore upon said party of the second part, and in case of such assignment the said party of the second part shall be free from all liability hereunder. In case of any disagreement as to the terms of this option or as to any matters connected with the exercise thereof, each party hereunto shall appoint an arbitrator and the two so appointed shall appoint a third, and the three arbitrators so selected shall be empowered to decide finally all matters of disagreement. Ch. 10] OPTION AGREEMENTS 1515 IN WITNESS WHEREOF, the Oswego Hub and Spoke Company, party of the first part, has caused its corporate name to be hereunto signed by its President and its duly attested seal to be hereunto affixed by its Secretary, and the party of the second part has affixed his signa- ture and seal, all on the day and year first above written. OSWEGO HUB AND SPOKE COMPANY, fcoRPORATE\ By JAMES O'REILLY, \ SEAL ] President Attest seal: HARRIS N. SEELEY, Secretary WILLIS P. EMERSON [L. s.] Witness signature of W. P. Emerson: MARY N. BATES CLARENCE WYMOND The following is a simple form of option on real estate. As realty is involved, it requires acknowledgment to be legally effective. Form 102. Option on Real Estate OPTION AGREEMENT This Agreement made this i8th day of June, 1922, for the sale of Real Estate, by and between Marcus M. McComb, party of the first part, and Melville H. Win- throp, party of the second part, witnesseth as follows: 1. That said party of the first part in consideration of Five Hundred Dollars ($500) to him in hand paid, does hereby agree to grant and convey to the party of the second part, his heirs, administrators, and assigns, all that certain lot of land together with the buildings, structures, and improvements thereon, situated, bounded, and described as follows: (Full description) 2. That said party of the first part hereby agrees to receive and accept in full payment for the said property, the sum of Twenty-Five Thousand Dollars ($25,- ooo), payable Ten Thousand Dollars ($10,000) cash on delivery of deed, and the remainder in three equal payments at one, two, and three years respectively, said deferred payments to be secured by mortgage on the said property and to bear interest at the rate of Six Per Cent (6%) per annum. 3. That said premises are to be conveyed subject to the following encum- brances. (Description of encumbrances) 4. That said party of the first part agrees to convey said property free from all liens and encumbrances, save as above specified, by such proper warranty deed containing full covenants duly executed and acknowledged, as shall convey and assure to the grantee the absolute fee of said premises. Provided, However, That unless said party of the second part or his assigns tenders the said amount of Ten Thousand Dollars ($10,000) and duly executed mortgage for the remainder of such purchase price on or before December, 1922, 1516 CORPORATE FORMS [Bk. IV- this agreement shall terminate and be of no force or effect and the party of the second part shall forfeit the amount already paid on this Option Contract, but no further liability of any kind shall be incurred by either of the parties hereunto. Witness the hands and seals of the said parties. MARCUS M. McCoMB [L. s.] MELVILLE H. WINTHROP [L. s.] In the presence of SAMUEL M. BOSWICK ELLEN M. JUDSON (Notarial acknowledgment according to the law of the state in which the contract is executed.) In the absence of any prohibiting provisions or conditions, an option contract is assignable as is any other form of con- tract. A simple option assignment is as follows : Form 103. Assignment of Option WHEREAS, The undersigned holds and is the lawful owner of a certain Option Contract, executed by the George F. Harper Company of Philadelphia, Pennsyl- vania, the undertaking of which is the sale of the wholesale hardware business now belonging to and conducted by the said George F. Harper Company, at No. 1725 Chestnut Street, in the City of Philadelphia, said business being more particularly specified and described in the said Option Contract hereunto attached and made part of this assignment: Now, THEREFORE, I, Theodore Paflin, in consideration of the sum of One Dol- lar, the receipt whereof is hereby acknowledged, and for other valuable and suffi- cient considerations, do by these presents grant, bargain, sell, transfer and assign unto the Allis-White Hardware Company, a corporation duly organized under the laws of the State of New York, all and singular, my entire right, title, and interest in and to the said Option Contract, to have and hold the same to the proper use and benefit of the said corporation. Witness my hand and seal this i6th day of December, 1921. THEODORE PAILIN [L. s.] Attest: IRVIN M. ROGERS VOTING TRUST AGREEMENTS Voting trusts are frequently formed at the time a corpora- tion is organized, and less commonly thereafter to secure certain Ch. 10] VOTING TRUST AGREEMENTS 1517 t" specified stock action. i The following is a simple form of voting trust agreement. Form 104. Voting Trust Agreement VOTING TRUST AGREEMENT We, the undersigned, stockholders of the Glen Harbor Improvement Company, a corporation duly organized under the laws of the State of New York, and having its' principal office in the City of Yonkers, in the State of New York, having trans- ferred and delivered to Emmett M. Brown, William Swift, and Andrew McBride, all of the said City of Yonkers, as Voting Trustees hereunder, the shares of stock held by each of us in said corporation, do hereby, in consideration of the premises and of the mutual undertakings hereinafter set forth, agree with them and with each other that said Trustees shall hold and vote the said stock for the period of five years from the date hereof, for the purposes and under the following terms and conditions : 1. All stockholders of the said Company may join in the voting trust hereby created, by signing this present agreement and transferring, in whole or in part, the shares of stock held by them in said Company to the said Trustees, under the conditions and for the purposes of this present agreerrent. 2. Each stockholder in said Company joining this voting trust as aforepro- vided shall become a party thereto from the date on which stock owned by such stockholder in said Company shall be transferred and delivered to said Trustees for the purposes of this agreement. 3. The said Trustees shall surrender to the proper officer of the said Glen Harbor Improvement Company, for cancellation, the certificates for all shares of stock transferred to said Trustees, and shall, in place thereof, have certificates of said Company issued to themselves as Trustees, and on the face of each said Trus- tees' certificate shall be stated the fact that such certificate has been issued pur- suant to this agreement. 4. The said Trustees shall collect and receive all dividends and profits accruing to said stock and shall pay over the same to the respective equitable owners thereof. 5. The said Trustees shall issue to each stockholder becoming a party thereto one or more transferable Trustees' receipts for the number of shares of stock placed by each of said stockholders respectively in this Voting Trust, and when such Trustees' receipts are duly transferred to other parties, said Trustees shall recognize such other parties as the lawful assigns and successors of the original parties hereto, entitled to all of their rights in the premises. 6. The stock held under this agreement shall, except as hereinafter specially provided, be voted at any meeting of the stockholders of said Company by such of the said Trustees as may be present thereat, and said stock shall be so voted as may in the judgment of a majority of the said Trustees present at any such meeting be for the best interest of the stockholders subscribing to this agreement. 7. In all elections of Directors the said stock shall be voted for the re-election of the present members of the Board of Directors of said Company, or, in the event of death, disability, or refusal to serve of any such members, the said stock shall be voted for such other person or persons as, in the judgment of said Trustees, shall be most suitable for such office. 1 For trustees' certificates, see Forms 82-84; for general discussion of voting trusts, see Book I, Ch. LVI, "Voting Trusts." 1518 CORPORATE FORMS [Bk. IV- 8. This agreement shall terminate five years from the date hereof, and upon such termination the said Trustees shall, as the outstanding Trustees' receipts are surrendered to them, duly indorsed, give over to the said Company the certificates of stock held by said Trustees, in pursuance of this agreement, properly indorsed, and shall direct the officers of said Company to deliver to the respective owners of the said surrendered Trustees' receipts certificates for such numbers of shares of stock as may be necessary to satisfy the requirements of the said surrendered Trus- tees' receipts. 9. In the event of the death, disability, resignation, or refusal to act of any of the Trustees herein named, the remaining Trustees or Trustee, shall have power to suitably fill such vacancy or vacancies, and the person or persons so appointed shall be empowered and authorized to act hereunder in all respects as if originally named herein. 10. A duplicate of this agreement shall be filed in the principal office of the said Company in Yonkers and shall there be kept for the inspection of any stock- holder of the Company, daily, during business hours. IN TESTIMONY WHEREOF, the parties to this agreement have hereunto affixed their hands and seals in the said City of Yonkers this 27th day of February, 1922. SHARES VOTING TRUSTEES STOCKHOLDERS ASSIGNED TO TRUSTEES EMMETT M. BROWN [L. s.] JAMES HALSEY [L. s.] 50 WILLIAM SWIFT [L. s.] ERNEST JURGENS [L. s.] 125 ANDREW MCBRIDE [L. s.] HAROLD M. GILSEY [L. s.j 75 WILLIS M. AMES [L. s.] 75 . Part II Forms Relating to Corporate Meetings CHAPTER XI CALLS AND WAIVERS FOR SPECIAL MEETINGS SPECIAL MEETINGS OF STOCKHOLDERS i Regular meetings both of stockholders and directors are held at fixed times prescribed by the by-laws. If in the interim between these' regular meetings matters arise calling for as- sembled action, special meetings become necessary. Such meet- ings are convened either by the call and waiver, or by a formal call followed by notice. The call and waiver is a single instrument consisting of two parts: first, a call for the desired meeting; and second, a waiver of all statutory, charter, or by-law requirements for notice thereof. This call and waiver must be signed by every person entitled to be present at its meeting. Those signing are thereby estopped from any future objection to the omission of the usual or required formalities as to notice of the meeting. No one else has a right to object; hence the call and waiver may be safely used even though the by-laws provide a different method of assembling special meetings. The call followed by notice is the method of assembling special meetings usually prescribed by the by-laws, and in- volves the use of two separate instruments : first, the call signed by some competent party or parties; and second, pursuant to this call, a notice of the meeting. The call and waiver permits of an immediate meeting, or a later meeting, according to its 1 For general discussion, see Book I, Ch. XLIII, "Special Meetings of Stockholders." 1519 1520 CORPORATE FORMS [Bk. IV- terms. The call with notice involves the delay incident to formal notice, ranging from three to ten days. The first meetings of both stockholders and directors are usually assembled by means of calls and waivers. It is, however, but seldom that the call and waiver is employed thereafter to assemble meetings of stockholders, on account of the difficulty save in the smaller corporations of securing the signature of every party entitled to be present at the meeting. Special meetings of the directors are usually assembled by means of the call and waiver. Forms of calls and waivers to assemble the first meetings of stockholders and directors have already been presented. 2 The following form is for use after organization: Form 105. Call and Waiver for Special Meeting of Stockholders CHELTINGHAM LINEN COMPANY CALL AND WAIVER SPECIAL MEETING or STOCKHOLDERS We, the undersigned, all the stockholders of the Cheltingham Linen Company of Trenton, New Jersey, hereby call a special meeting of the stockholders of said Company to be held in the Company's office, No. 275 Main Street, Trenton, New Jersey, on the 2ist day of May, 1922, at 3 o'clock in the afternoon, for the purpose of considering and acting upon a proposition for the consolidation of this Company with the Wilson Thread Company of Trenton, New Jersey, and we hereby waive all statutory and by-law requirements as to notice of time, place, and objects of said meeting, and agree to the transaction thereat of any and all business pertaining to the affairs of the Company. Trenton, N. J., JAMES H. McLAiN FRANK H. SMALL May 17, 1922 THEODORE McGowAN WILLIAM T. MASTERS JOSEPH H. FRENCH JOHN H. MEADE CHARLES P. HENDERSON HENRY T. ARNOLD DAVID B. ADAMS WILLIAM ROLLANDS - Where the number of stockholders is large, the call fol- lowed by notice is used in assembling special meetings. The call itself authorizes the meeting as set forth in its terms. When a call for a special meeting is issued by the president, it should be addressed to the secretary. - Forms 90, 95- Ch. n] CALLS AND WAIVERS FOR MEETINGS 1521 Form 1 06. President's Call for Special Meeting of Stockholders HUDSON NAVIGATION COMPANY 270 Broadway, New York Mr. HENRY H. SHELDON, Secretary of the HUDSON NAVIGATION Co.: You are hereby authorized and instructed to send out notice of a special meeting of the stockholders of this Company hereby called by me, said meeting to be held in the office of the Company, No. 270 Broadway, New York City, on the 1 5th day of February, 1922, at 10 A.M., for the purpose of considering and acting upon a proposition to sell the entire property and assets of the Company, and for the transaction of any and all business in connection therewith that may properly come before said meeting. February i, 1922 HARRY M. MOODY, President A more formal call for a special meeting of stockholders is given below : Form 107. President's Call for Special Meeting of Stockholders Formal PACIFIC COAST OIL COMPANY 1987 Broadway, New York Mr. HOWARD A. KENNARD, Secretary of the PACIFIC COAST OIL COMPANY DEAR SLR: In accordance with the authority vested in me by the By-laws of this Company I hereby call a special meeting of the stockholders of this Company, to be held in the office of the Company, No. 129 Exchange Place, New York, on the i5th day of March, 1922, at 10 o'clock in the forenoon, for the purpose of considering and acting upon a proposition to sell the entire property and assets of the Company, and for the transaction of any and all business in connection therewith that may properly come before said meeting, and I hereby aushorize and instruct you to give due notice of said meeting to the stockholders of this Company in accordance with the requirements of its By-laws. March i, 1922 HARRY M. CASSON, President The president's call for a special meeting is handed or sent to the secretary who thereupon sends out notices of the meeting. 3 ' See Forms 118-120. 1522 CORPORATE FORMS [Bk. IV- A directors' call for a special meeting of stockholders must, according to the requirements of the by-laws, be addressed either to the president, who in his turn instructs the secretary to issue notice of the meeting so called, or to the secretary as in the following form. Occasionally the by-laws permit direct publication notice by the directors when a special meeting of stockholders is to be assembled. Form 108. Directors' Call for Special Meeting of Stockholders CALL FOR SPECIAL MEETING OF STOCKHOLDERS We, the undersigned, Directors of the Hudson Navigation Company, do hereby call a special meeting of the stockholders of said Company to be held in its office, No. 270 Broadway, New York, on the i5th day of February, 1922, at 10 o'clock in the forenoon, for the purpose of taking action on a proposition to sell the entire property and assets of the Company, and for the transaction of any and all business necessary in connection therewith, and we do hereby authorize and instruct the Secretary of the Company to send out notice of said special meeting in accord- ance with the by-law requirements of this Company. New York City, New York, JOHN H. GOODRICH February i, 1922 HENRY B. MERRILL ARTHUR C. McCALL To Mr. HENRY H. SHELDON, Secretary of the HUDSON NAVIGATION Co. This call is handed or sent to the secretary, and is followed by his notice of the meeting. When the^by-laws provide that the president shall call special meetings on written request or in- struction signed by a prescribed number of directors, the fore- going call might be modified to meet the conditions as'follows: Form 109. Directors' Instructions for Special Meeting of Stock- holders To Mr. HARRY M. MOODY, President of the HUDSON NAVIGATION Co.: We, the undersigned, Directors of the Hudson Navigation Company, do hereby authorize and instruct you to call a special meeting of the stockholders of said Company, to be held in its office, No. 270 Broadway, New York, on the isth day of Ch. n] CALLS AND WAIVERS FOR MEETINGS 1523 February, 1922, at 10 o'clock in the forenoon, for the purpose of taking action on a proposition to sell the entire property and assets of the Company and for the trans- action of any and all business necessary in connection therewith. New York City, New York, JOHN H. GOODRICH February i, 1922 HENRY B. MERRILL ARTHUR C. MCCALL These instructions are handed to the president, who in accordance therewith issues his call for the meeting. If Form 107 is used for the purpose, the first phrase, "In accordance with the authority vested in me by the By-laws of this Com- pany," should be modified to, "Pursuant to written instructions of Directors of this Company." Special meetings of stockholders may always be called by resolution of the board of directors. Form no. Directors' Resolution for Special Meeting of Stock- holders RESOLUTION BE IT RESOLVED, That a special meeting of the stockholders of this Company be and hereby is called, said meeting to be held in the office of the Company at No. 270 Broadway, New York City, on the i5th day of February, 1922, at 10 o'clock in the forenoon, for the purpose of considering and acting upon a proposition to sell the entire property and assets of the Company, and for the transaction of any and all business necessary or desirable in connection therewith. As the secretary is presumably present at the meeting of the directors, or otherwise has access to the minutes, the mere passage of such a resolution is sufficient notice to him of the call, and he should send out notice of the meeting. It is but seldom that the stockholders issue a request or call for a meeting. Usually when they do, it must, in accord- ance with by-law requirements, pass through the president's hands. If not so prescribed, their call may be addressed to the secretary, in which case the president's only official knowledge of the meeting is derived from the notice sent him by the secre- 1524 CORPORATE FORMS [Bk. IV- tary. Occasionally the by-laws authorize the stockholders to give direct notification of the meeting by publication. Form in. Stockholders' Request for Special Meeting To the President of the ADAMS MACHINE COMPANY:- We, the undersigned, owning or controlling not less than two-thirds of the entire voting stock of the Adams Machine Company, do hereby request you to call a special meeting of its stockholders to be held in the office of the Company at No. 35 Broad St., New York, at 3 o'clock in the afternoon on the ist day of March, IQ22, for the purpose of considering the purchase, proposed by the Directors of this Company, of the machine shop and equipment of the Harrison Metal Working Company, located at 908 Willoughby St., Brooklyn, and to take such action in regard thereto as may seem necessary or desirable to the stockholders present at such meeting, and we request you to have due and timely notice thereof sent to each stockholder of this Company. New York City, N. Y. February 10, 1922 NAME DAVID H. BENTLEY JAMES J. ALLISON OLIVER P. CHANDLER STANLEY S. WOOD HENRY M. SHERRILL SPENCER HARRISON SHARES OWNED 2OO 250 500 ISO 300 15 This stockholders' request is handed to the president, who may either indorse his call on the request as in the form which follows, or may issue the more formal call shown in Forms 106 and 107. Form 112. President's Indorsement of Stockholders' Request To the Secretary of the ADAMS MACHINE COMPANY: You are hereby instructed to give due notice of a special meeting of the stock- holders of this Company hereby called by me in pursuance of the within stock- holders' request, said meeting to be held in the office of the Company at No. 35 Broad St., New York City, at 3 P.M., on the ist day of March, 1922, in accordance with and for the purposes set forth in the said request. New York City, N. Y., JOHN H. HARRELL, February 10, 1922 President When the stockholders' call is directed to the secretary, its form will be as follows : Ch. n] CALLS AND WAIVERS FOR MEETINGS 1525 Form 113. Stockholders' Call for Special Meeting To the Secretary of the HOWARD WOOLEN MILLS Co.: We, the undersigned, stockholders of the Howard Woolen Mills Company owning or controlling not less than two-thirds of its entire voting stock, do hereby call a special meeting of the stockholders of the Company to be held in its office at No. 45 Main St., Dunkirk, New York, at 12 o'clock noon on the isth day of January, 1922, for the purpose of considering a proposition to so amend the By-laws as to restrict the President's power to contract for the Company, and of taking such action in regard thereto as may seem necessary or desirable to the stockholders present at such meeting, and we do hereby authorize and instruct you to send out notices of said meeting in accordance with the terms of this present call. Dunkirk, New York, NAMES SHARES OWNED January 3, 1922 HENRY B. CLARKE 575 HARRY H. HOWARD 1200 FRANK B. JOHNSON 725 SAMUEL FURMAN 500 SPECIAL MEETINGS OF DIRECTORS* Special meetings of directors are usually assembled by means of calls and waivers, except where the board is large or some of its members are inaccessible. The common form of call and waiver for directors' meetings is as follows: Form 114. Call and Waiver for Special Meeting of Directors CALL AND WAIVER SPECIAL MEETING OF DIRECTORS We, the undersigned, all the Directors of the Long Island Power Company of Flushing, Long Island, do hereby call a special meeting of the Board of Directors of said Company to be held in its office at No. 285 Duane St., New York City, at 4 P.M., on this 2ist day of May, 1922, for the purpose of acting upon a proposition for the sale of the Company's Flushing plant; and we do hereby waive all statutory and by-law requirements as to notice 01 time, place, and purposes of said meeting, and consent to the transaction thereat of any and all business pertaining to the affairs of the Company. New Yoik City, N. Y., JOHN MCFERGUSON May 21, 1922 HAROLD H. HARDING BENTON CRELLER HOWARD H. MAURICE HORACE EVANS 'For general discussion of special meetings of directors, see Book I, H 422-425. 1526 CORPORATE FORMS [Bk. IV- Special meetings of directors are sometimes irregularly assembled, as for instance where all the members of a board come together on some informal notice or without previous notice, and then and there, agree to waive all the usual formali- ties and hold an immediate meeting. Such meetings, termed "consent meetings," are entirely legal and are not uncommon where boards of directors or executive committees are small and easily assembled. For such meetings a written validation is not strictly neces- sary. The participation of all the parties entitled to be present, duly entered on the minutes of the meeting, affords legal evi- dence of their consent thereto and estops any subsequent ob- jections on their part to the proceedings. As a precautionary measure, however, the secretary should have every member of the board sign the minutes of a consent meeting, or otherwise sign a waiver of notice and agreement to the meeting as given below: Form 115. Agreement for Consent Meeting of Directors HARRISON CUTLERY COMPANY WAIVER OF NOTICE We, the undersigned, all the Directors of the Harrison Cutlery Company, being now present, do hereby consent to an immediate meeting of the Board of Directors of said Company to be held in the office of Henry M. McCall, No. 253 Broadway, New York, at 3 P.M. this i4th day of February, 1922, and we hereby waive all requirements as to notice of time, place, and purposes of such meeting, and agree to the transaction thereat of any and all business pertaining to the affairs of the Company. HENRY H. McCAix SIMON FRANKENSTEIN JAMES J. McCALL HOWARD H. FRENKEL STANLEY T. BROWN When a special meeting of directors is desired and it cannot be assembled by call and waiver, perhaps because of the absence of one or more directors, or because of a refusal on the part Ch. n] CALLS AND WAIVERS FOR MEETINGS 1527 of one or more directors to sign the call and waiver, it must be assembled by call and notice. In such case the call must be signed as required by the by-laws usually by the president or a certain number of the directors. A form of president's call is given on the following page. This call is handed to the secretary who, in accordance with its instructions, follows it up with the usual notice of the meeting. 5 Form 116. President's Call for Special Meeting of Directors CORLISS TYPEWRITER COMPANY 35 Vesey St., New York January 10, 1922 Mr. JOHN H. HAMMOND, Secretary CORLISS TYPEWRITER Co. DEAR SIR: In accordance with the authority vested in me by the By-laws of this Company, I hereby call a special meeting of the Board of Directors to be held in office of the Company on the 20th day of January, 1922, at 3 o'clock in the afternoon, for the purpose of considering and acting upon the appointment of a western selling agent and for the transaction of any other business in connection therewith that may be necessary, and you are hereby authorized and instructed to send out notices of said meeting as required by the By-laws of this Company. JOHN H. PHILLIPS, / President The by-laws frequently provide that special meetings of the board may be called by a certain number of the directors. This call is usually addressed as in the folio wing form and handed to the secretary direct. Form 117. Directors' Call for Special Meeting of Directors CALL FOR SPECIAL MEETING or DIRECTORS We, the undersigned, Directors of the Manhattan Photo Supply Company, hereby call a special meeting of the Directors of said Company, to be held in its office, No. 1575 St. Nicholas Ave., New York, on the i?th day of February, 1922, See Form itf. 1528 CORPORATE FORMS [Bk. IV- at ii A.M., for the purpose of considering and acting upon a proposition to purchase the plant and equipment of the Adams Automatic Camera Company, and for the transaction of any and all business necessary in connection therewith, and we hereby instruct the Secretary of the Company to send out notices of said special meeting in accordance with the By-law requirements of this Company. New York City, HENRY C. CARSON February 5, 1922 FRANK H. MERRILL SAMUEL FRENKEL To Mr. JOHN H. HERSEY, Secretary MANHATTAN PHOTO SUPPLY Co. CHAPTER XII NOTICES OF MEETINGS STOCKHOLDERS' MEETINGS * Every person entitled to be present at a corporate meeting is also entitled to notice of such meeting. If the notice to be given is prescribed by the charter, by-laws, or statutes, this is always sufficient, but if not so determined, "reasonable notice" is then necessary and this requires such notice as will under ordinary circumstances enable the parties notified to attend without being specially inconvenienced. Notice of a special meeting must accord as to the time, place, and purposes thereof with the call by which the meeting is authorized. The authority under which it is issued should be stated in the notice. Form 118. Notice of Special Meeting of Stockholders HUDSON NAVIGATION COMPANY NEW YORK CITY, NEW YORK, February i, 1922 Mr. ARTHUR C. McCAix, 227 Broadway, New York. DEAR SIR: You are hereby notified that pursuant to the call of the President, a special meeting of the stockholders of the Hudson Navigation Company will be held in the office of the Company, No. 270 Broadway, New York, on the 15th day of February, 1922, at 10 A.M., for the purpose of considering and acting upon a proposition to sell the entire property and assets of the Company, and for the transaction of any and all business in connection therewith that may properly come before said meeting. Yours very truly, HENRY H. SHELDON, Secretary > For general discussion, see Book I, { 270, 306, 414. IS29 1530 CORPORATE FORMS [Bk. IV- When notice of a special meeting is to be published, the following form is frequently used. The same form also serves as a notice to be sent by mail. Form 119. Publication Notice of Special Meeting of Stockholders NOTICE OF SPECIAL MEETING OF STOCKHOLDERS CROSS LABORATORIES, INC. A special meeting of the stockholders of this Company will be held on the i6th day of January, 1922, at two o'clock in the afternoon, at the principal office of the corporation, No. 347 Madison Avenue, New York, N. Y., for the purpose of chang- ing the name of the company from "CROSS LABORATORIES, INC.," to "LARSON MANUFACTURING COMPANY, INC.," and for the transaction of such other business in connection therewith as may properly come before the meeting. GEORGE V. LARSON, President E. M. HILTON, Secretary New York City, December 31, 1921. The following gives an excellent form of notice for a special meeting of stockholders. T. Form 120. Publication Notice of Special Meeting of Stockholders WESTERN UTAH RAILROAD COMPANY SPECIAL MEETING OF STOCKHOLDERS 120 BROADWAY, NEW YORK, March 26, 1922 To the STOCKHOLDERS of the WESTERN UTAH RAILROAD COMPANY: Notice is hereby given that a special meeting of the stockholders of Western Utah Railroad Company has been called by the Board of Directors to convene at the office of the Company at Salt Lake City, in the State of Utah, on the 5th day of May, 1922, at 10 A.M., for the purpose of considering and acting upon a proposi- tion for the sale of the Company s entire assets to the Salt Lake City Air Line as set forth below. (Purposes here) Ch. 12] NOTICES OF MEETINGS 1531 The books for the transfer of the stock (both preferred and common) will be closed for the purpose of the meeting, at 12 noon, on the nth day of April, 1922, and will be reopened at 10 A.M. on the 6th day of May, 1922. By order of the Board of Directors. JOHN HAMILTON, Secretary Notice of the annual meeting must be sent out in accordance with the requirements of the by-laws. Form 121. Notice of Annual Meeting HARMON PUBLISHING COMPANY 765 Main St., Dover, Delaware May i, 1922 Mr. FRANCIS H. JAMIESON, 336 Ocean Ave., Atlantic City, N. J. DEAR SIR: You are hereby notified that the annual meeting of the stockholders of the Harmon Publishing Company will be held at the office of the Company in Dover, Delaware, on Tuesday, May 15, 1922, at 10 A.M., for the elections of five Directors for the ensuing year and for the transaction of such other business as may come before the meeting. The stock transfer books of the Company will be closed at 3 P.M., May 5, 1922, and remain closed until 10 A.M., May 16, 1922. Respectfully, JAMES H. HOWARD, Secretary In a number of states the statutes require the publication of the notice of the annual meeting. The following forms are suitable for this purpose. Form 121 may also be easily modified to serve as a publication notice. Form 122. Publication Notice of Annual Meeting HARMON PUBLISHING COMPANY 765 Main St., Dover, Delaware May i, 1922 Notice is hereby given that the annual meeting of the stockholders of the Harmon Publishing Company will be held at the office of the Company at 765 Main 1532 CORPORATE FORMS [Bk. IV St., Dover, Delaware, May 15, 1922, at 10 A.M., for the election of five Directors and for the transaction of such other business as may be brought before said meeting. The stock transfer books of the Company will be closed at 3 P.M., May 5, 1922, and remain closed until 10 A.M., May 16, 1922. JAMES H. HOWARD, . Secretary Form 123. Publication Notice of Annual Meeting THE CORPORATION TRUST COMPANY (New York) NOTICE OF ANNUAL MEETING The annual meeting of the stockholders of The Corporation Trust Company will be held on the i8th day of January, 1922, at twelve o'clock noon, at the office of the company, No. 37 Wall Street, New York, N. Y., for the purpose of electing two Directors of the Second Class, receiving and acting upon the reports of the officers and for the transaction of such other business as may properly come before the meeting. HORACE S. GOULD, Secretary Dated, December 20, 1921 Form 124. Publication Notice of Annual Meeting GREAT WESTERN RAILROAD COMPANY ANNUAL MEETING 120 BROADWAY, NEW YORK, August 13, 1921 The annual meeting of the stockholders of the Great Western Railroad Com- pany will be held at the office of the Company in Chicago, Illinois, on Tuesday, February 14, 1922, at twelve noon, for the following purposes, viz.: (i) To elect fifteen Directors; (2) To consider and act upon an amendment to Article XVI of the Company's By-laws; (3) To transact all such other business as may legally come before the meeting, including the approval and ratification of all action of the Board of Directors and of the Executive Committee since the last Annual Meeting of the stockholders of the Company. For the purposes of the meeting the books for the transfer of stock, both pre- ferred and common, will be closed at 3 P.M. on Wednesday, February i, 1922, and will be reopened at 10 A.M. on Wednesday, February 15, 1922. JOHN HAMILTON, Secretary Ch. 12] NOTICES OF MEETINGS 1533 DIRECTORS' MEETINGS 2 It is but rarely that publication notices are used in assembling directors' meetings. Either of the following notices might be readily modified, if desired, to serve as a publication notice. Consent meetings, from their nature, do not permit of any formal notice. The following is a simple form for notice of special meet- ing of directors. It would either be mailed or delivered in person. Form 125. Notice of Special Meeting of Directors HYDRO-CARBON STEEL COMPANY 134 West 23rd St., New York City January 3, 1922 Mr. WALTER H. SINCLAIR, Montclair, New Jersey DEAR SIR: You are hereby notified that pursuant to call of the President, a special meet- ing of the Board of Directors of this Company will be held in its office at 3 P.M. on the i8th day of January, 1922, to act upon a proposition to purchase the plant of the Scranton Foundry Company and to transact such other business in connec- tion therewith as may be necessary or desirable. Respectfully, MILTON H. SANDERSON, Secretary This notice must be sent to every member of the board. The time, place, and purpose of the meeting must be stated, and, unless every member of the board is present and agrees thereto, no business may be transacted at the meeting save that so specified. The following notice is the usual formal notice of the regular meeting of directors. If desired, a printed form might be used with blanks for the dates and addresses. 1 For general discussion, see Book I, 55 286 424.. 1534 CORPORATE FORMS [Bk. IV- Form 126. Notice of Regular Meeting of Directors HYDRO-CARBON STEEL COMPANY 134 West 23rd St., New York City March 15, 1922 Mr. WALTER H. SINCLAIR, Montclair, New Jersey DEAR SIR: You are hereby notified that the regular quarterly meeting of the Board of Directors of the Hydro-Carbon Steel Company will be held in the office of the Company, No. 134 West 23rd St., New York, on Tuesday, March 28, 1922, at 3 P.M. Respectfully, MILTON H. SANDERSON, Secretary CHAPTER XIII PROXIES FOR MEETINGS A proxy is merely a special power of attorney and may convey any authority as to the representation of his stock the maker desires up to the limit of his own. 1 The powers conferred by a proxy are limited strictly to those specified. Thus a proxy to vote on a proposed amend- ment of the charter at a certain meeting would not authorize the holder to vote also upon a proposed amendment of the by-laws though considered at the same meeting. The time for which a proxy runs is also governed strictly by the provisions of the instrument unless sooner terminated (i) by statutory or by-law provisions, (2) by the death of the maker, (3) by the sale of his stock, (4) by his formal revocation filed with the secretary, or (5) for the meetings at which he ap- pears, by the presence and participation thereat of the maker. A proxy given for a particular meeting holds good for any meeting adjourned therefrom, whether so specified in the proxy or not. A: proxy should be in writing, but it is not necessarily in any particular form; it need not be acknowledged or proved, but it must be in such a shape as reasonably to satisfy the in- spectors of election of its genuineness and validity. To meet this requirement the proxy should be signed and sealed by the maker and be witnessed by at least one person, but does not ordinarily require acknowledgment. It may cover all or any part of the stock owned by an individual, and two or more proxies may be given by a single stockholder, each proxy cover- 'For general discussion, see Book I, li 275, 401. IS3S 1536 CORPORATE FORMS [Bk. IV- ing a part of his holding, or each authorizing action on different propositions. A proxy may be revoked by the maker at any time even though by its terms the proxy is irrevocable. The only ex- ception to this rule is where occasionally a proxy is coupled with an interest in the stock on which the proxy is given. The revocation of a proxy should be in writing and be filed with the secretary of the meeting. The mere presence of the ownei of the stock at any meeting, with the express intention of voting his stock thereat, has the effect of revoking for that meeting all outstanding proxies given by him. If a proxy is issued while a prior proxy for the same stock is outstanding, a revocation of the first proxy should be incorporated in the second. Should this not be done, the more recent proxy will on presentation revoke the first, but the absence of formal revocation is a suspi- cious circumstance, liable to provoke inquiry and cause trouble. Notices of the annual meetings of the larger corporations are usually accompanied by proxy forms, which stockholders unable to be present at the meeting in person are requested to sign and send in to the corporate officials. In this way a quorum is often secured when otherwise it would fail. The plan is some- times utilized with much effect for the purpose of securing a majority for some measure favored by the directors of the com- pany, or to secure the election or re-election of parties desired as directors by those in control. Proxies sent with notices of meetings sometimes name the party or parties to act, but are frequently sent out with the names omitted, and are then usually returned signed in blank; i.e., while duly signed and witnessed, the name of the person who is to act as proxy is omitted. The name of the secretary or some- one else present at the meeting is then inserted and the instru- ment so completed is legally effective. Proxies signed in blank are usually employed in any case where the name of the party to act has not been definitely decided upon or where it is immaterial. In this shape the Ch. 13] PROXIES FOR MEETINGS 1537 proxy can be used by anyone into whose hands it may come. When once completed, however, by the insertion of the name of the party to act, it can be used only by the specified party, nor can this party authorize anyone else to vote the stock covered by the proxy unless the proxy itself distinctly con- fers upon him full rights of substitution. Directors cannot give proxies authorizing others to repre- sent and vote for them at directors' meetings. The directors occupy a position of trust and they cannot as individuals dele- gate the trust vested in them to others. This is a settled principle of law. When the proxies are to be used they are filed with the secretary of the meeting. If the holder desires to retain his original proxy, he may, after exhibiting the original, file a certified copy with the secretary of the meeting. Form 127. Proxy Simple Form PROXY I hereby appoint George H. Brewer my proxy with full authority to vote for me and in my place at any and all stockholders' meetings of the Brewer Plow Company. Witness my hand and seal this ?th day of May, 1922. HAROLD J. McCoRMiCK [L. s.] Witnessed by HENRY F. SIMMONS This proxy is under most circumstances legally sufficient and the powers it conveys are broad. A more formal proxy is, however, desirable when important matters are to be con- sidered. The proxy which follows is still simple as to form but more specific in its terms. Form 128. Proxy Unlimited PROXY I, the undersigned, do hereby constitute and appoint George J. McClelland my true and lawful attorney to represent me at any and all meetings of the stock- 1538 CORPORATE FORMS [Bk. IV- holders of the Carney Falls Spinning Company, and for me and in my name and stead to vote thereat upon the stock standing in my name on the books of said Company at the times of said meetings, and I hereby grant my said attorney all the powers that I should myself possess if personally present thereat. Witness my signature and seal this i$th day of January, 1922. HAROLD B. MCCLELLAND [L. s.] In the presence of ALPHONSE H. DURET At the expiration of the specified term the following proxy becomes null and void without formal revocation or other action on the part of the maker. Form 129. Proxy Time Limited PROXY I, the undersigned, do hereby constitute and appoint Henry M. Williams my true and lawful attorney to represent me at all meetings of the stockholders of the Carney Falls Power Company held on or prior to the isth day of June, 1923, and do hereby authorize and empower him for me and in my name and stead to vote at such meetings upon the stock now standing in my name on the books of said Company, and I hereby grant my said attorney all the power at said meetings that I should myself possess if personally present thereat. Witness my signature and seal this ist day of February, 1922. SAMUEL B. FREMONT [L. s.] In the presence of J. J. MASTERSON It should be noted that the wording of the foregoing proxy authorizes the appointee to vote only upon the stock "now standing in my name." Should the maker dispose of this stock prior to the expiration date of the proxy, the proxy would of course be automatically terminated and be of no further effect. Should the maker acquire additional stock of the company after the date of this proxy but during its life, such additional stock is not covered by the proxy. In this the proxy differs from the proxy of Form 128 which covers all stock owned by the maker "at the times of said meetings." Ch. 13] PROXIES FOR MEETINGS 1539 Form 130. Proxy for Particular Meeting PROXY KNOW ALL MEN BY THESE PRESENTS: That I, the undersigned, do hereby constitute and appoint Kenneth J. Johnson my true and lawful attorney with full powers of substitution and revocation, to represent me at the special meeting of stockholders of the Graham Navigation Company, to be held on the igth day of June, 1922, at 3 P.M., and do hereby authorize and empower him to vote at said meeting and at any adjournment thereof, for me and in my name and stead, upon the stock then standing in my name on the books of said Company, and I hereby grant my said attorney all the powers that I should possess if personally present at said meeting. Witness my signature and seal this ist day of May, 1922. MELVER M. McKiM [L. s.] In the presence of HENRY P. SWENTON Outside its limitation as to time, the preceding proxy is broad. It not only covers all stock held in the name of the maker at the time of meeting and empowers the appointee to act as fully and with the same authority as the owner might himself, but also empowers him to give and revoke proxies conveying similar voting powers to others. If it is not desired to convey these latter powers, the words "with full power of substitution and revocation" should be omitted. If all the stock covered by a proxy is disposed of before the date of meeting, such proxy is, as already stated, thereby nullified. If part of the stock is sold, the proxy still holds for the remaining stock. If a proxy specifies the number of shares of stock to be voted upon, such proxy is good for the number of shares standing in the maker's name up to the specified number. The following form may be used when but a portion of the stock owned by a stockholder is to be represented by his proxy. A single stockholder may give several such proxies to cover his entire holding of stock, the object being to admit several repre- sentatives to the proceedings of the meeting. The following proxy does not convey any greater or more complete powers than the shorter forms heretofore considered, 1540 CORPORATE FORMS [Bk. IV- but is more specific and conventional and therefore preferable when matters of importance are to be considered and acted upon. Form 131. Proxy Limited as to Stock PROXY I, the undersigned, do hereby nominate and appoint John H. McConnell my true and lawful attorney, for me and in my name, place, and stead to vote at all stockholders' meetings of the Fowler Watch Company upon Twenty-five Shares of the stock of said Company standing in my name, and I hereby grant my said attorney all the powers as to said Twenty-five Shares of stock that I would myself possess if personally present at such meetings. Witness my signature and seal this roth day of March, 1922. FRANCIS P. STERLING In the presence of HARRY H. FRENCH Form 132. Proxy for Annual Meeting Formal PROXY KNOW ALL MEN BY THESE PRESENTS: That, we, the undersigned, stockholders of the Carney Falls Power Company, do hereby constitute and appoint J. Adam McCall our true and lawful attorney with full power of substitution and revocation, for us and in our names, place, and stead to vote upon the stock then standing in our respective names upon the books of said Company, at the annual meeting of the stockholders thereof to be held in the office of the Company, 425 Fifth Ave., New York City, January 17, 1922, at 10 o'clock in the forenoon, and at any meeting postponed or adjourned therefrom, hereby granting to our said attorney full power and authority to act for us, and in our names and stead to vote thereat upon our said stock in the election of directors and in the transaction of such other business as may be brought before the said meeting, all as fully as we might or could do if personally present, and we hereby ratify and confirm all that our said attorney or his substitute shall lawfully do at such meeting in our names, place and stead. IN WITNESS WHEREOF, we have hereunto affixed our respective signatures and seals this 2nd day of November, 1921. S. S. FOLSOM [L. s. HENRY M. CLEVELAND [L. s. J. B. McLAiN [L. s. SARGENT McLAiN [L. s. In the presence of WILLIAM J. HAMMOND as to S. S. Folsom and Henry M. Cleveland JERRY T. MCALLISTER as to J. B. McLain and Sargent McLain Ch. 13] PROXIES FOR MEETINGS 1541 If corporate stock is held by a corporation in its own name, the proxy might be given under the corporate name as in the following general form. Form 133. Corporate Proxy PROXY KNOW ALL MEN BY THESE PRESENTS : That the Steel Company of the Republic, a corporation organized under the laws of the State of Pennsylvania, owning and holding Five Hundred Shares of the Capital Stock of the Howard Welding Company of New York City, does hereby constitute and appoint Frederick W. Morton of New York City its true and lawful attorney to attend the annual meeting of the aforesaid Howard Welding Company to be held in its office, No. 22 Broad St., New York, on Monday, January 16, 1922, at 10 o'clock in the forenoon, and thereat for this Company and in its name, place, and^stead to vote upon the said Five Hundred Shares of stock, and to do all such other things competent to a stockholder of said Howard Welding Company, as may in his judgment be necessary or advantageous for the interests of this Company, and to that end the said Steel Company of the Republic does hereby grant to its said attorney for said meeting, and for any meetings adjourned therefrom, any and all powers belonging to or pertaining to this Company as a stockholder of the aforesaid Howard Welding Company, hereby ratifying and confirming all that its said attorney may lawfully do at said meeting in its name, place and stead. IN WITNESS WHEREOF, the President and Secretary of the said Steel Company of the Republic, duly authorized thereto, have hereunto affixed the signature and seal of their said Company, all being done in the City of Philadelphia, Pennsylvania, on this 3rd day of January, 1922. STEEL COMPANY OF THE REPUBLIC, / CORPORATE \ By JOHN H. SHERMAN, \ SEAL j President Attest seal: WILLIAM M. MCDONALD, Secretary In some states the statutes empower the corporate officials to vote the stock of other corporations held by their corpora- tion. In such case no proxy is necessary, but a certification that the official representing the company is its official, properly representing the company, is required. 1542 CORPORATE FORMS [Bk. IV- Form 134. Revocation of Proxy REVOCATION OF PROXY KNOW ALL MEN BY THESE PRESENTS: That I, the undersigned, do hereby revoke and annul any and all proxies or powers of attorney heretofore given by me, authorizing or empowering any person or persons to represent me, or vote in my name and stead or act for me in any way whatsoever at any meeting or meetings of the stockholders of the Carney Falls P.ower Company. Witness my signature and seal this loth day of May, 1922. DANIEL H. RONALDS [L. s.] In the presence of JOHN H. DUNN The foregoing revocation of outstanding proxies is sweeping in its terms. If some particular proxy is to be excepted from the general revocation, such proxy may be specifically reserved, or otherwise the revocation may itself be limited by its terms to the one or more proxies to be revoked, in which case any other outstanding proxies are not affected. CHAPTER XIV MOTIONS AND RESOLUTIONS In the course of corporate meetings, whether of stockholders or directors, anything to be done that is obviously proper and of no great importance may be merely ordered by the president, as for instance, the reading of the minutes of the previous meeting, or the riling of some paper or report, and, in the absence of objection, this is held to be the action of the meeting. Matters of more importance are sometimes acted upon in this same way, but usually, and preferably, action is then taken by means of either a motion or a resolution. There is no distinct line of demarcation between these two. They differ as to form but both are expressions of the decisions of the meeting and are of the same legal force. The motion is the simpler in form, and, though there is no well-established rule, is usually employed for matters of minor importance; while resolutions, which are formal and usually go further into their subject matter, are employed for such important corporate actions as require a more complete statement and record. Motions are not as a rule submitted in writing. The secre- tary must therefore exercise every care to get the sense of what is intended. If he is in doubt in any case as to whether he has understood the motion, or if its subject matter is of unusual importance, or if it is desirable that the exact wording be pre- served, the presiding officer should request the maker of the motion to repeat it, or, better, to reduce it to writing. When this is done, the written motion is turned over to the secretary, and, if carried, is incorporated in his minutes in the exact form submitted. The following forms show motions as they should appear in 1543 1544 CORPORATE FORMS [Bk. IV- the secretary's minutes. The form is the same for either stockholders' or directors' minutes. Form 135. Motion Instructing Secretary to Cast Vote There being no other nominations, the Secretary was instructed by motion unanimously carried, to cast the single ballot of the meeting for the five candidates for Directors already named. Form 136. Motion Instructing Secretary to Cast Vote Formal On motion unanimously carried, the Secretary was instructed to cast the single ballot of the meeting as follows: For President John H. McNeil " Vice-President Samuel French " Secretary Harry McGill " Treasurer Joseph F. Macklin An amendment to the by-laws is usually acted upon by means of a resolution. In the following instance, as the amend- ment is of minor importance it is decided by motion. Form 137. Motion to Amend By-Laws By motion unanimously carried, Section i of Article II of the By-laws was amended by changing the hour for the assembling of the annual meeting of the Company from 12 o'clock noon to 3 P.M. Form 138. Motion to Pay Bills Upon motion duly seconded and unanimously carried, the Treasurer was in- structed to pay the account of the Meyer Contracting Company for One Hundred and Thirty-Five Dollars, due for repairs on roof of the Franklin Mill as per state- ment submitted. Usually the secretary uses his discretion as to recording the names of the parties making and seconding motions. They are not essential in the case of routine motions, motions covering matters of minor importance, or motions unanimously carried. Ch. 14] MOTIONS AND RESOLUTIONS 1545 Under other circumstances the name of the party making and also the party seconding a motion should be recorded. The vote on important motions when there is opposition, is sometimes recorded as well. Form 139. Motion to Employ General Manager Mr. Henry Sheldon moved that James J. McLain be employed as General Manager of the Company for a term of two years from date, at the annual salary of Four Thousand, Five Hundred Dollars payable in monthly instalments. The motion was seconded by Mr. Charles H. Corbett and carried; Messrs. Sheldon, McLemore, Corbett, and Johnson voting in the affirmative, and Messrs. Franklin, Hereford, and Trask in the negative. A motion in writing should appear on the minutes in the exact form submitted, as in the following example, and should be introduced by an explanatory statement, as "The following motion offered by Mr. Wilson was duly seconded and carried by unanimous vote." Form 140. Motion to Appoint an Investigating Committee Moved, that the President be authorized and directed to appoint a Committee consisting of three Directors of this Company, to investigate the books and accounts of the Treasurer for the past three years, such Committee to have full access to the Company's financial records and to have authority to employ an Auditor to con- duct the technical work of their examination, the compensation of said Auditor not to exceed the sum of Three Hundred Dollars. Resolutions should be submitted in writing. They are entered in the minutes prefaced with such explanatory remarks as the conditions require or the secretary thinks desirable, as "Upon motion duly made and seconded the following resolution was unanimously adopted," or "The following resolution was presented by Mr. Cassellton, seconded by Mr. Edwards and adopted, Messrs. Cassellton, Edwards, Brice, and McNeil voting in the affirmative, and Messrs. Mack and Adams voting in the negative." A preamble to a resolution is always ad- missible but, if its subject matter is simple, is not necessary. 1546 CORPORATE FORMS [Bk. IV- There is no difference in form between a resolution adopted by the stockholders and one adopted by the directors. Form 141. Stockholders' Resolution for Sale of Entire Assets 1 WHEREAS, William F. Gaynor and James G. Reilly, as Trustees before organi- zation for the New Hampshire Granite Company, have made a proposition to purchase the entire plant and business of this Company as a going concern, includ- ing all assets and liabilities, save cash in bank and on hand, for Ten Thousand Dol- lars ($10,000) in cash and Forty Thousand Dollars ($40,000) par value of the stock of said New Hampshire Granite Company: Now, THEREFORE, BE IT RESOLVED, That the said proposition be hereby ap- proved, and that the Directors of this Company be and hereby are fully authorized, instructed, and empowered to accept the said proposition for the sale of its entire property and business, and to do all things necessary to carry such acceptance into effect according to the terms of said proposition. Form 142. Stockholders' Resolution Authorizing Consolidation WHEREAS, A consolidation of the Midvale Foundry Company and the Wanaque Steel Company under the name of the New Jersey Steel Foundry Com- pany, has been proposed by the Wanaque Steel Company on terms and conditions approved by the Board of Directors of this Company; and WHEREAS, Said proposed consolidation on the terms set forth meets with the approval of the stockholders of the Company: Now, THEREFORE, BE IT RESOLVED, That the Board of Directors of this Com- pany be and hereby is fully authorized, empowered, and instructed to take all such steps as may be necessary or desirable to carry said consolidation into effect in accordance with the terms submitted by the said Wanaque Steel Company. Form 143. Stockholders' Resolution to Amend By-Laws WHEREAS, Section 2 of Article IV of the By-laws of this Company relating to the President reads and provides in part as follows : "He may also,- in the absence or disability of the Treasurer, indorse checks, drafts, and other negotiable instruments for deposit or collection, and shall, with the Secretary, sign the minutes of all meetings over which he may have presided." AND WHEREAS, It seems to the stockholders of the Company that the interest of the Company will be better conserved if these duties are assigned to the Vice- President of the Company, save as to the signature to minutes: Now, THEREFORE, BE IT RESOLVED, That said Section 2 of Article IV of said By-laws be and hereby is amended as to the part above set forth to read and pro- vide as follows: 1 For corresponding directors' resolution, see Form 159. Ch. 14] MOTIONS AND RESOLUTIONS 1547 'He shall, with the Secretary, sign the minutes of all meetings over which he may have presided." and that Section 3 of Article IV of said By-laws relating to the Vice-President be amended by the addition of the following provision: "He may, in the absence or disability of the Treasurer, indorse checks, drafts, and other negotiable instruments for deposit or collection." The following is a simple form of resolution authorizing the treasurer to open a bank account. It should be certified before submission to the bank. Form 144. Directors' Resolution to Open Bank Account RESOLVED, That the Treasurer be and hereby is authorized and instructed to open an account for the Company with the Irving National Bank of New York City, and to deposit therein all funds of the Company coming into his possession, such account to be in the name of the Company and funds deposited therein to be withdrawn only by check signed by the Treasurer and countersigned by the President. In some cases the designated bank requires a certified transcript of any by-laws giving the duties and powers of the officers in relation to the funds. Such by-laws may be certified separately, or may be included in the resolution, as in the following example: Form 145. Directors' Resolution Designating Depositary 2 WHEREAS, Section 3, Article VII of the By-laws of the Standard Milling Com- pany is as follows: "The Moneys of the Company shall be deposited in the name of the Com- pany in such bank or banks as the Board of Directors shall designate, and shall be drawn out only by check signed by the Treasurer and countersigned by the President, unless otherwise provided by resolution of the Board." Now, THEREFORE, In pursuance of said By-law, the Board of Directors of the Standard Milling Company hereby designates the Sherman Trust Company of New York City as a depositary of this Company, and authorizes and instructs the Treasurer to open an account with said Trust Company in the name of the Com- pany, and to deposit therein all funds of the Company coming into his custody, save as may be otherwise directed by the Board, said funds to be withdrawn only by check signed by the Treasurer and countersigned by the President 1 For certification, see Form 225. 1548 CORPORATE FORMS (a IV- In many cases, as already stated, 3 the banks have their own ' forms of resolution for designation of the corporate depositary, which they supply on request and which they naturally prefer should be used. As a rule these forms are good, though occasion- ally the latitude and power they confer upon the officers of the corporation are somewhat excessive. If this is the case, the resolution may be so modified as to eliminate these undesirable provisions while still preserving its general form. The resolution which follows is used by some of the large New York banks. Form 146. Directors' Resolution Designating Bank RESOLVED, That the Sherman National Bank of the City of New York be and the same is hereby designated as the depositary of the funds of the American Tex- tile Company, and that an account be opened with such Bank in the name of said Company, and that George H. Wahrman, the Treasurer of said Company, so long as he shall be Treasurer thereof, is hereby authorized to sign or indorse any instru- ment for or on behalf of said Company and have the same placed to the credit of said account, and also from time to time withdraw or .transfer by check or draft or other instrument signed by him and countersigned by Henry G. Maxim, Presi- dent of the said American Textile Company, or any successor President of said Company, any amount or parts thereof which may from time to time be to the credit of said account; and RESOLVED, FURTHER, That the respective powers and the authority conveyed by this present resolution shall pass to any duly elected and qualified successor Treasurer or President of the said American Textile Company without further action of this Board, and as fully and to the same extent as if said successor officer were named herein. Under this resolution, if a new treasurer or president is elected, nothing is necessary save for the election and acceptance of the new official to be certified to the bank by the secretary of the company. 4 Form 147. Directors' Resolution Authorizing Issue of Stock RESOLVED, That the President and Treasurer be and hereby are authorized and directed to issue certificates of the full-paid Capital Stock of this Company to the aggregate amount of Ten Thousand Dollars ($10,000), and to deliver the same to the written order of Robert H. Stuart, Fiscal Agent for the Company, against pay- ment into the treasury of the Company of the full par value thereof. 1 Ch. IX, "Organization Meeting of Directors." * See Forms 227, 228. Ch. 14] MOTIONS AND RESOLUTIONS 1549 Form 148. Directors' Resolution Authorizing Contract RESOLVED, That the President and Secretary be and hereby are authorized and instructed to enter into a contract with the Wilbur Collins Construction Com- pany on behalf of this corporation, for the erection of a power house, the construc- tion of said power house to be in accordance with the plans and specifications on file in the office of this corporation, and the cost thereof not to exceed Twenty-Five Thousand Dollars ($25,000), payment thereof to be made as set forth in the written proposition heretofore submitted to this corporation by the said Wilbur Collins Construction Company. Form 149. Directors' Resolution Declaring Dividend RESOLVED, That the sum of Ten Thousand Dollars ($10,000) be and hereby is appropriated and set aside from the surplus profits of this Company for the pay- ment of the regular Two Per Cent (2%) quarterly dividend upon its outstanding stock, said dividend to be due and payable on the 2oth day of May, 1922, to stock- holders of record as shown by the books of the Company at the close of business on the isth day of May, 1922. RESOLVED FURTHER, That the Treasurer of this Company be hereby author- ized and instructed to give notice of such dividend and to pay the same when due. Form 150. Directors' Resolution Declaring Dividend Preferred Stock RESOLVED, That the semiannual dividend of Three Per cent (3%) upon the outstanding Preferred Stock of the Company be and hereby is declared from sur- plus profits, said dividend to be paid on the zoth day of March, 1922, and to be payable to stockholders who appear of record on the it day of March, 1922, at 3 P.M., and that the Treasurer of this Company be hereby instructed and fully authorized to give due notice of such dividend and to .pay the same on the date set forth. Form 151. Directors' Resolution Declaring Dividend Preferred and Common Stock WHEREAS, The surplus profits of this Company now exceed the sum of Ten Thousand Dollars ($10,000) required by the By-laws of this Company to be in reserve before dividends may be paid upon either the preferred or common stock of this Company, and such excess is now available for payment of dividends: Now, THEREFORE, BE IT RESOLVED, That a dividend of Five Per Cent (5%) be and hereby is declared upon the outstanding Preferred Stock of this Company, and a dividend of Three Per Cent (3%) on the outstanding Common Stock of this Company, said dividends to be payable from said excess surplus profits of the Company on the $th day of March, 1922, to stockholders appearing of record at 3 P.M., on this isth day of February, 1922; and that the Treasurer of this company 1550 CORPORATE FORMS [Bk. IV- be hereby fully authorized and instructed to give proper notice of said dividends, to pay the same when due, and to take all other necessary steps to carry out the intent of the present resolution. Form 152. Directors' Resolution Appointing Managing Director RESOLVED, That Mr. William S. Weston be hereby appointed Managing Direc- tor of this Company and be given the general supervision and management of the Company's affairs and business, with such other powers and duties as the Board of Directors may from time to time confer upon him; the annual salary of said Man- aging Director to be Forty-Eight Hundred Dollars ($4,800), payable in monthly instalments of Four Hundred Dollars ($400) each. Form 153. Directors' Resolution Calling Special Meeting of Stockholders WHEREAS, The authorized Capital Stock of this corporation is One Hundred Thousand Dollars ($100,000) divided into One Thousand (1,000) Shares of Com- mon Stock of the par value of One Hundred Dollars ($100) each, of which Five Hundred (500) Shares are issued and Five Hundred (500) Shares are unissued; and WHEREAS, It is deemed advisable by this Board that said Capital Stock shall be so classified and divided into Common and Preferred Stock that the said Five Hundred (500) Shares of outstanding stock shall be and remain Common Stock, but shall be of no par value; and that the said Five Hundred (500) Sharesof unissued stock shall become and be non-voting Preferred Stock of the par value of One Hundred Dollars ($100) each, entitled to receive a cumulative, preferred dividend of Seven Per Cent (7%) per annum and redeemable at its par value at the option of the Company at any time after ten years from the date of its issue, and upon the liquidation of the Company to be redeemed if outstanding, at its full face value from the assets before any payment is made upon the Common Stock, but not to participate further in said assets: Now, THEREFORE, BE IT RESOLVED, That a special meeting of the stockhold- ers of this Company be and hereby is called to meet in the office of the Company on the loth day of May, 1922, at 10 o'clock in the forenoon, for the purpose of considering and acting upon the proposed classification of the stock of this Com- pany as afore set forth, and that the Secretary of the Company be hereby author- ized and instructed to send out notices of said meeting as required by law and by the By-laws of this Company. This resolution conforms to the requirements of the New York laws, classification of the company's stock requiring authorization by the stockholders. Form 154. Directors' Resolution to Sell Bonds RESOLVED, That Howell & Wilkins of New York City be and hereby are authorized and empowered to sell bonds of this Company to the aggregate face Ch. 14] MOTIONS AND RESOLUTIONS 1551 value of One Hundred Thousand Dollars ($100,000), and to deduct from the price received therefor a commission of Two Per Cent (2%), provided, however, that the net price received by this Company for each One Thousand Dollar ($1,000) Bond shall not be less than Nine Hundred and Eighty Dollars ($980) ; and RESOLVED, FURTHER, That the Treasurer of this Company be and hereby is authorized and instructed to deliver said bonds in whole or in part on the written order of the said Howell & Wilkins, and to receive and receipt for all amounts paid by them into the treasury of the Company on account of sales of said bonds. Form 155. Directors' Resolution to Purchase Property RESOLVED, That the President and Treasurer of the Company be and hereby are authorized and instructed to purchase the West Valley marl beds in accordance with the terms of the option under which said beds are now held, and that they be further authorized and empowered to do all such things for and on behalf of the Company and in its name as may be necessary to the consummation of said purchase. Form 156. Directors' Resolution for Settlement of Claim RESOLVED, That the President and Secretary of this Company, acting with its Counsel, be hereby instructed to use their best efforts to arrive at some favorable settlement with the employees of this Company injured in the recent accident, and that said officers be hereby fully authorized and empowered to agree to any settle- ment deemed by them satisfactory and approved by the Counsel of the Company, provided that the total payments involved therein shall not exceed the sum of Twenty -five Hundred Dollars ($2,500). Form 157. Directors' Resolution Ratifying Sale of Property WHEREAS, The President and Treasurer of this Company have heretofore on the 2ist day of January, 1922, sold and disposed of the machinery, tools, and other apparatus belonging to this Company and then in the premises at 235 Main St., Newark, New Jersey, the amount realized from such sale Two Thousand, Seven Hundred and Fifty Dollars ($2,750) having been duly paid into the treasury of this Company; and WHEREAS, Said sale was made without authorization from this Board owing to the absence from the city of so many of its members that a quorum could not be secured; and WHEREAS, In the opinion of the Board such sale was for the best interests of the Company, and the action of said officers in consummating the same therefore meets with its approval: Now, THEREFORE, BE IT RESOLVED, That the action of the said officers of this Company in selling and disposing of the aforementioned property as aforesaid, be and hereby is ratified, approved, and confirmed, and that said action be accepted as the action of the Company, and the bills of sale and assignments thereof be ratified, confirmed, and accepted as the duly executed assignments of this Com- pany, of the same force and effect as if entered into under direct authorization of this Board. 1552 CORPORATE FORMS [Bk. IV- In some few states the statutes give the directors power to remove an objectionable official. The following resolution embodies such action taken in accordance with the statutes Form 158. Directors' Resolution Removing Officer (New York) WHEREAS, In the opinion of this Board the interests of the Company do not permit the continuance in his present official position of its President, John Farra- day; and WHEREAS, The said John Farraday has refused to resign although requested thereto by members of this Board duly authorized thereunto: Now, THEREFORE, BE IT RESOLVED, That exercising, its statutory power the Board of Directors of the Manly Electric Corporation does hereby remove the said John Farraday from his official position as President of this Company, and declares said office vacant and said John Farraday no longer authorized to act on its behalf in any capacity; and RESOLVED 'FURTHER, That the Secretary of the Company be and hereby is instructed to notify at once the said John Farraday of his removal from the presi- dency of this Company, and to give such other proper and public notice of said removal as may in his judgment be necessary to protect the interests of the Com- pany. Form 159. Directors' Resolution for Sale of Entire Assets 5 WHEREAS, A proposition has been made by the Trustees of the New Hamp- shire Granite Company to purchase the entire property and business of this Com- pany for Ten Thousand Dollars ($10,000) in cash and Forty Thousand Dollars ($40,000) in stock of the said proposed corporation as set forth in their written proposition heretofore ordered to be spread upon the minutes of this meeting; and WHEREAS, The stockholders of this Company in duly assembled meeting at which all the voting stock of the Company was represented in person or by proxy, did by resolution unanimously carried, approve said sale and authorize and in- struct this Board to accept said proposition: Now, THEREFORE, BE IT RESOLVED, That the said proposition be and the same is hereby accepted by this Company on the terms set forth in said written proposition as entered upon the minutes of this meeting, and the President and Secretary of the Company are hereby empowered and instructed to execute all proper instruments to carry such acceptance into effect, and on behalf of this Company to receive the said Ten Thousand Dollars ($10,000) in cash and Forty Thousand Dollars ($40,000) in stock of the said New Hampshire Granite Company, and to do all such other things in connection with such sale and the said transfer of property as may be found necessary for its proper consummation. * For corresponding stockho;ders' resolution, see Form 141, CHAPTER XV FORMS USED IN CONNECTION WITH MEETINGS The secretary will find a list of stockholders, giving the stock held by each and arranged as in the following form, of much convenience for use at stockholders' meetings. This does not take the place of the statutory list required in some states, but is merely for use in calling the roll or noting those present and absent, and the proxies for those absent. Form 1 60. Secretary's List of Stockholders INDUSTRIAL SUPPLY COMPANY LIST OF STOCKHOLDERS January 3, 1922 1 NAME SHARES OWNED NOT PRESENT PRESENT IN PERSON PRESENT BY PROXY NAME OF PROXY Adrian, Henry F. 100 100 n Ahrens, Sam'l T. 5 50 Allison, Daniel H. 75 75 George T. Foster Barry, John J. 85 85 Belmont, Maurice 2 5 2 5 Colville, Frederick IOO IOO Daniels, E. F. IOO 50 5 Harry H. Winters Greenwald, Martin 80 80 William Greenwald Hughes, Cora H. !SO !50 Lawrence, Edw. 25 25 McCabe, Albert 50 5 ' W. B. Wells Mullins, Chas. D. 35 35 Price, Harvey 200 200 Rollins, James H. 5 5 Henry Siebert Shanley, J. J. 25 25 Sherman, B. L. 150 15 Wiley, Edwin H. IOO IOO Harry T. French Zimmer, Henry T. IOO IOO 1,500 15 945 405 . 1553 1554 CORPORATE FORMS [Bk. IV- The list as shown is after the secretary's notations have been made. The data of the first two columns are taken from the stock books of the company before the time of the meeting. If a stockholder is not represented at the meeting, a. check mark, or, better, the number of his shares, is entered in the third column. If present in person, the number of shares owned is entered in the fourth column. If represented by proxy, the number of his shares is entered in the fifth column, and the name of the person holding the proxy in the last column. It will be noted that in the foregoing list, a portion of the holding of one stockholder is entered in the column "Not Pres- ent" and a portion is entered in the column "Present by Proxy." This shows that the party gave a proxy for a portion of his stock and that the person to whom this was given was present, while the remaining stock was not represented, this latter stock losing its vote. The list, when the secretary's notations are finished, gives a complete record of the attendance at the meeting. The com- bined footing of columns four and five give the number of shares represented, which added to the footing of column three should give the total stock outstanding. At the annual meeting routine work is apt to be gone through with some rapidity and the secretary does not always have time for its proper record unless provision is made therefor prior to the meeting. For this purpose, in addition to the list of stockholders, outline minutes as shown below are frequently prepared. These outline minutes are best arranged on sheets of loose paper with ample room between the items for the interpolation of any comments or additional matter. They are merely intended to afford memoranda from which the secretary may later write out the complete minutes. If, through unexpected changes or omissions, any portion of the outline minutes cannot be used, the secretary has merely to draw his pencil through the part to be eliminated. Ch. 15] FORMS USED IN MEETINGS 1555 Form 161. Outline Minutes for Annual Meeting INDUSTRIAL SUPPLY COMPANY OF NEW YORK MINUTES OF ANNUAL MEETING Held January 16, 1922 Meeting called to order at A.M., by who presided over meeting. Officiating Secretary Present at meeting in person Shares. By Proxy Shares. Total Shares. Necessary for quorum, 751 Shares. Copy of notice of meeting submitted with secretary's certificate of due service attached. Ordered spread upon minutes. Minutes of previous meeting read and Annual Reports: President's Treasurer's Special Election of Directors. Nominated: Inspectors of Election: Results: New business: In some states the statutes require that the election of directors must be conducted by inspectors. Elsewhere they or similar officers designated as tellers, are employed as a matter of convenience. Usually inspectors are not sworn, but in some states this is required by the statutes or is a matter of custom. The oaths and certificates of inspectors of election in the general form employed in New York follow. They may be easily modified to meet the statutory requirements of other states where oaths and certificates are required. 1556 CORPORATE FORMS [Bk. IV- Form 162. Oath of Inspectors of Election New York OATH OF INSPECTORS OF ELECTION STATE OF NEW YORK 1 . COUNTY OF NEW YORK/ We, the undersigned, duly appointed to act as Inspectors of Election at the annual meeting of the stockholders of the Alvin Auto Car Company, held in the office of the Company, No. 72 Broadway, New York, on the 2nd day of February, 1922, being severally duly sworn, depose and say and each for himself deposes and says that he will faithfully execute the duties of Inspector of Election at such meeting with strict impartiality and according to the best of his ability. FRANK H. ASTOR DAVID J. McKANE Severally sworn to before me this 2nd dav of February, 1922 ALLEN T. BAUVELT, Notary Public in atid for /NOTARIAL\ New York County \ SEAL ] The oath of the inspectors of election and their certificate as to the election results as given in the form which follows are usually written, as a matter of convenience, on one sheet of paper, the oath preceding the certificate. Form 163. Certificate of Inspectors of Election New York CERTIFICATE OF INSPECTORS OF ELECTION We, the undersigned, duly appointed Inspectors of Election of the Alvin Auto- Car Company of New York City, New York, do hereby certify that at the regular annual meeting of said corporation, held in the office of the Company, No. 72 Broad- way, New York City, on the 2nd day of February, 1922, a quorum being present, we being first duly sworn by oath hereunto annexed, did conduct the election for Directors of said corporation and that the result of the vote taken thereat was the election by the plurality vote set opposite their respective names, of the following Directors: NAMES VOTES RECEIVED Charles E. Shepherd 2,135 Frank J. Platt 2,000 Harry P. Tucker 1,97 Edward T. Bowles 1,875 Henry P. Moody 1,825 George McDonald 1,825 Albert T. Calkins 1,800 IN TESTIMONY WHEREOF, we have executed this certificate this 2nd day of February, 1922. FRANK H. ASTOR DAVID J. McKANE Ch. 15] FORMS USED IN MEETINGS 1557 In New York the inspectors' oath and certificate must be filed in the county clerk's office. Form 1 64. Acknowledgment of Inspectors' Certificate STATE OF NEW YORK } COUNTY OF NEW YORK/ On this 2nd day of February, 1922, before me personally came Frank H. Astor and David J. McKane, to me known to be the persons described in and who executed the foregoing certificate and severally acknowledged that they executed the same for the use and purposes therein set forth. ALLEN T. BAUVELT, (NOTARIAL! Notary Public in and for \ SEAL / New York County When not required by statute, the formality of swearing inspectors is usually dispensed with. An inspectors' report is, however, a convenient method of preserving the results of an election, and the written report is therefore desirable. Its form under such circumstances might be as follows: Form 165. Certificate of Inspectors of Election General CERTIFICATE OF INSPECTORS OF ELECTION We, the undersigned, duly appointed Inspectors of Election of the Hamilton Machine Company of Philadelphia, Pennsylvania, to conduct the election of Directors of said Company held this i4th day of March, 1922, at 3 P.M., in the office of the Company, No. 15 Chestnut St., Philadelphia, Pa., do hereby certify and report that said election was conducted by us in due and proper form, and that the result of the vote taken thereat by ballot was the election by the plurality vote set opposite their respective names of the following directors : NAMES VOTES RECEIVED E. L. Lambert 200 John C. Robinson 200 Walter S. Hall 200 William H. Sloane 200 Alvah H. Marshall 200 IN WITNESS WHEREOF, we hereunto affix our respective signatures this i4th day of March, 1922. ARTHUR T. NEWMAN GEORGE HAYWOOD A simple form of ballot for the annual meeting is shown below. This is prepared before the time of the meeting, com- plete when the candidates' names are known in advance 1558 CORPORATE FORMS [Bk. IV- save as to signature and the number of shares voted. If there are more candidates than the number of directors to be elected, the space where the names are to appear would, of course, be left blank. Form 166. Ballot at Annual Meeting MAXIM WATCH COMPANY BALLOT ANNUAL MEETING, JANUARY 10, 1922 I, the undersigned, hereby vote 125 shares of stock for the following named persons to serve as Directors for the ensuing year: John H. Brown Frank T. Jones Howard McCall Fowler McVeigh Marvin H. Smith Signature, HAROLD McKAiN, Proxy for Samud H. Hilton Where a more formal ballot is desired the following will serve : Form 167. Ballot at Annual Meeting Formal UNITED STATES POTTERIES BALLOT SIXTEENTH ANNUAL MEETING, APRIL 20, 1922 The undersigned votes the number of shares noted in the subscription hereto as follows: 1. In favor of approving and ratifying all purchases, contracts, acts, pro- ceedings, elections, and appointments by the Board of Directors or the Finance Committee, since the fifteenth annual meeting of the stockholders of the Corpora- tion on April 15, 1921, as set forth in the minutes of the Board of Directors, or of the Finance Committee, or in the Fifteenth Annual Report. 2. For the following named persons, as Directors for the three years ending in 1925: NAME NUMBER OF SHARES PREFERRED COMMON in person proxy for 3. For the firm of Jones, Williams & Company, as independent auditors, to audit the books and accounts of the Corporation at the close of the fiscal year ending December 31, 1922 CHAPTER XVI MINUTES OF CORPORATE MEETINGS The general form in which minutes are kept is a matter of custom. The details are determined by the secretary of the particular company. The headings should, however, always be sufficiently full and explicit to show at a glance whether the meeting is of stockholders or directors and whether it is a regular, special, or adjourned meeting. The date of the particular meeting, though always stated in the body of the minutes, should also appear in the heading as a matter of con- venience. The name of the corporation is frequently brought in at the head of every set of minutes. When this is not done the minute book itself should be very plainly stamped or marked with the name of the company, which should also appear on the title page of the book and again at the top of the first written page of minutes. Form 168. Minutes of Annual Meeting of Stockholders ' MIDVALE FOUNDRY COMPANY of New Jersey MINUTES OF REGULAR MEETING OF STOCKHOLDERS Held March 2, 1922 The stockholders of the Midvale Foundry Company met in annual meeting in the office of the Company at Midvale, New Jersey, at 10 o'clock in the forenoon, March 2, 1922. The meeting was called to order and presided over by Frederick H. Colgate, President of the Company. The Secretary of the Company, W. A. Thompson, acted as Secretary of the meeting. 1 See Ch. XLII, "Annual Meeting of Stockholders. " 1559 1560 CORPORATE FORMS [Bk. IV- The Secretary after noting the stockholders present, reported that out of a total of 5,000 shares of stock outstanding and entitled to vote at the meeting, 4,900 shares were represented at the meeting; 3,500 shares in person, and 1,400 shares by proxies filed with the Secretary. The Secretary then read a copy of the notice of the meeting, with his certificate attached showing that a copy thereof had been mailed to each stockholder of record on or before the i7th day of February, 1922. He fclso presented copies of the Newark Advertiser and the Jersey City Journal under date of February 18 and 25, 1922, containing due advertisement of the meeting. The proof of notice as pre- sented was ordered received and filed. The Secretary produced the stock and transfer books of the Company, together with an alphabetical list giving the name, residence, and number of shares of stock held by every stockholder entitled to vote in the election of directors. This list remained open to inspection during the election of directors and for the entire time of the meeting. The minutes of the preceding annual meeting were then read and approved. The minutes of the special meeting of stockholders held December 10, 1921, were also read and approved. Upon motion duly seconded and carried, Messrs. W. B. Johnson and D. L. Boyd were appointed Inspectors of Election, were duly sworn, and the meeting then proceeded to the election of Directors. The election was held by ballot and the polls were opened at 10:15 o'clock A.M. and closed at 11:15 o'clock A.M. The Inspectors thereupon presented their report in writing showing that Frederick H.' Colgate, Benson R. Vale, William R. Buchanan, Malcolm R. Rigby, and Robert H. McCarter had received a plurality of all the votes cast, and the said parties were thereupon declared to be the duly elected Directors of the Company for the ensuing year and until the election of their successors. The annual report of the President was then presented and upon request was read by him. The report was by unanimous motion ordered received, and filed. The Treasurer's annual report was submitted, and, no objection being offered, was ordered received and filed. The report of the committee appointed at the special meeting of stockholders held December 10, 19.21, to examine the accounts of the Company, was received, and by motion its findings were approved and the report ordered received and filed. Upon motion duly made and unanimously adopted, the Board of Directors were authorized to secure plans and estimates for enlarging the plant of the company. There being no further business before the meeting, a motion to adjourn was unanimously adopted. FREDERICK H. COLGATE, W. A. THOMPSON, President Secretary Form 169. Minutes of Special Meeting of Stockholders 2 MIDVALE FOUNDRY COMPANY of New Jersey MINUTES OF SPECIAL MEETING OF STOCKHOLDERS Held March 20, 1922 The stockholders of the Midvale Foundry Company assembled in special meeting in the office of the Company at Midvale, New Jersey, at 10 o'clock in the See Ch. XLIII, "Special Meetings of Stockholders. " Ch. 16] MINUTES OF MEETINGS 1561 forenoon on the loth day of March, 1922, pursuant to call of the President followed by due notice thereof to the stockholders. The Meeting was called to order by Frederick H. Colgate, President of the Company; the Secretary of the Company, W. A. Thompson, officiating as recording officer. The entire capital stock of the Company was represented at the meeting, either in person or by proxy filed with the Secretary. 'The Secretary presented the Call and Notice pursuant to which the meeting was held, with his certificate that said notice had been sent out not less than twenty days before the date of meeting. The Call and Notice were ordered spread upon the Minute Book immediately following the minutes of the meeting. The President then stated briefly that the meeting was assembled to consider a proposition from the Wanaque Steel Company for the consolidation of the two companies under the general name of the New Jersey Steel Foundry Company, the new company to have a capitalization of One Million, Five Hundred Thousand Dollars ($1,500,000) and stock in both companies to be exchanged for stock of the new company, share for share. A discussion of the proposition disclosed considerable opposition mainly on the ground that the financial conditions of the Wanaque Steel Company were not such as to make the desired consolidation advantageous. Replying to this objection, the President stated that the financial statement of the Wanaque Steel Company as presented in the proposition from that Company, apparently misrepresented its real condition, and suggested that an adjournment of the meeting be taken until 10 A.M. on the following day, in order to permit the officers of the Wanaque Steel Company to furnish authoritative information on this point. No objection being offered to this suggestion, the President declared the meeting adjourned to assemble again in the office of the Company at 10 A.M., March 21, 1922. FREDERICK H. COLGATE, W. A. THOMPSON, President Secretary Form 170. Minutes of Adjourned Meeting of Stockholders MIDVALE FOUNDRY COMPANY of New Jersey MINUTES OF ADJOURNED SPECIAL MEETING OF STOCKHOLDERS Held March 21, 1922 (Adjourned from meeting of March 20, 1922) The stockholders of the Midvale Foundry Company met in adjourned meeting in the office of the Companyiat Midvale, New Jersey, at 10 o'clock in the forenoon on the 2ist day of March, 1922. Frederick H. Colgate called the meeting to order and presided. W. A. Thompson acted as Secretary of the meeting. * The stockholders of the Company were all present in person or by proxy. The minutes of the special meeting of stockholders held on the preceding day and from which the present meeting was adjourned, were read for the information of those present. 1562 CORPORATE FORMS [Bk. IV- The President then presented and read to the meeting a letter from the Treasurer of the Wanaque Steel Company, explaining satisfactorily the financial condition of that Company. The President further stated that the proposed consolidation had already been authorized, on the terms set forth, by the stockholders of the Wanaque Steel Company, and that if it were also authorized by the Midvale Foundry Company, the proper action would be taken by the Boards of Directors and officials of. the respective companies to consummate the consolidation at the earliest possible moment. The following resolution was then offered by Charles H. Curtis: WHEREAS, A consolidation of the Midvale Foundry Company and the Wanaque Steel Company under the name of the New Jersey Steel Foundry Company, has been proposed by the Wanaque Steel Company on terms and conditions approved by the Board of Directors of this Company; and WHEREAS, Said proposed consolidation on the terms set forth meets with the approval of the stockholders of the Company: Now, THEREFORE, BE IT RESILVED, that the Board of Directors of this Company be and hereby is fully authorized, empowered, and instructed to take all such steps as may be necessary or desirable to carry said consolidation into effect in accordance with the terms submitted by the said Wanaque Steel Company. After a short discussion, D. W. Jackson moved that the resolution be adopted. The motion was thereupon seconded by Henry B. Vale, and was carried by unanimous vote. Frederick W. Howard stated that the conditions made prompt action im- portant and asked that the Board be instructed to complete the pending con- solidation at the earliest possible moment. A motion to this effect was there- upon made and unanimously carried. There being no further business before the meeting, the President declared it adjourned. FREDERICK H. COLGATE, W. A. THOMPSON, President Secrctarv The proposition for consolidation presented at the special meeting of the stockholders of the Midvale Foundry Company, does not appear in connection with the foregoing minutes of that meeting, as it would properly appear in the minutes of the directors' meeting at which final action upon it is taken. The proposal does not have to be brought into the minutes of both meetings. The general form of directors' minutes is the same as for minutes of stockholders' meetings. It is, however, customary to enter the names of those present at the directors' meeting. Such an entry is not usually made in the case of stockholders' meetings. Ch. 16] MINUTES OF MEETINGS 1563 Form 171. Minutes of Regular Meeting of Directors 3 FAIRFIELD CEMENT COMPANY of New York MINUTES OF REGULAR MEETING or DIRECTORS Held December 15, 1921 The Board of Directors of the Fairfield Cement Company of New York assembled in regular meeting in the office of the Company, Fairfield, New York, at .} P.M. on Wednesday, December 14, 1921. The meeting was called to order and presided over by William A. Pierce, President of the Company. Morris H. Goodrich, Secretary of the Company, acted as Secretary of the meeting. Present: Messrs. William A. Pierce, John H. Pickering, Walter S. Laighton John K. Bates, Fred N. Barney, and Morris H. Goodrich, constituting a quorum of the Board. The minutes of the preceding meeting of September 9, 1921, and of the meet- ings of September 15 ana of September 18 and September 25 adjourned therefrom, were read and approved. The President reported that the new plant of the Company at the West Valley marl beds was progressing rapidly and should be completed on or before March i, 1 922. He also stated that arrangements had been made for the installation of the necessary machinery and for the general equipment of the plant, and that it was hoped it would be in full operation before the first of June, 1922. The President also reported that the Deering Construction Company was alxmt to contract for a large amount of cement, aggregating nearly One Hundred Thousand (100,000) barrels, with deliveries extending over a year, and that he felt confident that if the Company would make the proper concessions as to price that the contract could be secured, and asked that the Board authorize him to make such concessions not exceeding fifteen cents per barrel as might be necessary to secure said contract. The President further reported that additional funds amounting to about Forty Thousand Dollars ($40,000) would be required for the completion of the West Valley plant not later than February 15, 1922, and asked the Board to take such action as might be necessary to secure these needed funds. The Treasurer then submitted a report giving the receipts and expenditures for the past month and showing a present cash balance on hand of $15,525.25. The report was ordered received and filed. Arthur Hurd, Counsel for the Company, who was present by request, reported verbally that his investigations of the titles of the marl beds lying to the north of the Company's West Valley beds had disclosed some apparent imperfections, and he therefore advised the Board to postpone the consummation of the purchase of these beds until further investigation should show definitely that either the titles were or were not in satisfactory shape. The President's recommendations were then taken up, and after some discus- sion the President was authorized by motion unanimously carried to make such discounts to the Deering Construction Company not exceeding fifteen cents per barrel as might be necessary to secure the contract mentioned. The matter of finance for the West Valley plant was by unanimous consent deferred until the next meeting of the Board. . 3 See Ch. XLIV, "Meetings of Directors." 1564 CORPORATE FORMS [Bk. IV- The report of the Company's Counsel in regard to the marl beds north of the West Valley beds was then taken up for discussion. Walter S. Laighton urged that no lengthy delay should be permitted, stating that he was personally cognizant of the fact that other parties were desirous of securing these same marl beds, and that the present option under which the beds were held would expire in three weeks from date and he was positive could not be renewed at anything like the present option price. Arthur Hurd, Counsel for the Company, in answer to an enquiry from the presiding officer, stated that his investigations could be completed inside a week, and thereupon on motion duly carried, the meeting was adjourned to assem- ble again in the office of the Company, December 22, at 3 P.M. WILLIAM A. PIERCE, MORRIS H. GOODRICH, President Secretary Form 172. Minutes of Adjourned Meeting of Directors FAIRFIELD CEMENT COMPANY of New York MINUTES OF ADJOURNED MEETING or DIRECTORS Held December 22, 1921 (Adjourned from regular meeting of December 15, 1922) The Board of Directors of the Fairfield Cement Company met in adjourned meeting in the office of the Company at Fairfield, New York, at 3 o'clock in the afternoon on Thursday, December 22, 1921. The meeting was called to order and presided over by the President, William A. Pierce. The Secretary of the Company, Morris H. Goodrich, acted as Secretary of the meeting. There were present: Messrs. William A. Pierce, John H. Pickering, Walter S. Laighton, John K. Bates, Fred N. Barney, Silas H. Harvey, and Morris H. Good- rich, constituting a quorum of the Board. The minutes of the board meeting of December 15, 1921, were read for the information of those present. After the reading of the minutes, Arthur Hurd, Counsel for the Company, re- ported that his investigation of the titles of the marl beds lying north of the West Valley beds had been completed, that the apparent defects to which he had referred in his previous report had been explained satisfactorily, that he believed the titles to be in good shape, and that in his opinion the purchase of the beds could be safely consummated. Thereupon on motion of John H. Pickering, seconded by Walter S. Laighton and carried by unanimous vote, the following resolution was adopted: RESOLVED, That the President and Treasurer of the Company be and hereby are authorized and instructed to purchase the West Valley marl beds in accordance with the terms of the option under which said beds are now held, and that they be further authorized and empowered to do all such things for and on behalf of the Company and in its name as may be necessary to the consummation of said purchase. There being no further business before the meeting, it was adjourned. WILLIAM A PIERCE, MORRIS H. GOODRICH, President Secretary Ch. 16] MINUTES OF MEETINGS 1565 Form 173. Minutes of Special Meeting of Directors NORWICH METAL SPINNING COMPANY MINUTES OF SPECIAL MEETING OF DIRECTORS Wednesday, February 16, 1922 The Directors of the Norwich Metal Spinning Company met, pursuant to Call and Waiver of Notice signed by all the Directors of the Company, in the offices of the Company at 2 P.M., February 16, 1922. William S. Dickenson, Chairman of the Board, presided, and Henry B. Horton acted as Secretary of the meeting. There were present: Henry B. Horton, John Harrison, Philip G. Sanderson, William S. Dickenson, and Howard Dickenson, constituting the entire membership of the Board. The Chairman stated that the special business before the meeting was a propo- sition to increase the capitalization of the -Company from Four Thousand Shares of no par value, to Ten Thousand Shares of no par value, this in order to give a margin of common stock that could be sold to provide the capital needed for the Company's rapidly expanding business. He also stated that if the suggested in- crease of capitalization were carried out, it was proposed to issue Five Thousand Shares of the new no-par-value stock to the present holders of common stock, these stockholders receiving for each share of common stock now held by them one and one-quarter shares of the new stock. This would leave Five Thousand Shares of the new stock unissued to meet the future requirements of the Company. He also stated that the plan contemplated a sale of so much of the unissued stock as might be authorized by the Board at Fifty Dollars a share, and the exchange of the new common stock for the outstanding preferred stock of the Company of the par value of One Hundred Dollars at the option of the preferred holder on the basis of two shares of no-par-value common stock for each share of preferred. After a full discussion of the suggested plan, the following resolution was moved and adopted by the unanimous vote of all present. RESOLVED, That the Board of Directors does hereby approve the increase of the common capital stock of the Company from Four Thousand Shares of no par value, to Ten Thousand Shares of no par value, and does hereby authorize the proper officers of the Company to take all such steps as may be necessary to secure the consent of the stockholders of the Company to such increase, and, this consent being secured, to take such further steps as may be necessary to make the proposed increase effective. The Board also passed the following resolution as a statement of the plan to be carried out when and if the common stock of the company is increased as con- templated. RESOLVED, That in event of the proposed increase of common stock being effected, the Board approves the retirement of the present outstanding cer- tificates of common stock, and the issue to the holders thereof, in exchange therefor, of new certificates on the basis of one and one-quarter shares of the new common stock for each one share of the old common stock; And in event of said increase being effected, the Board also approves the sale of Two Thousand Shares of said new common stock at the rate of Fifty Dollars a share, preference in said sale of common stock to be given first to officers and to the employees of the Company, and then to outsiders friendly 1566 CORrORATE FORMS [Bk. IV- to the Company, no more, however, than Five Hundred Shares of stock to be sold to any one individual. And in event of said increase of common stock being effected, the Board further approves the exchange of two shares of said common stock for each one share of the preferred stock of the Company now outstanding, said exchange to be made at the option of the holder of such preferred stock and upon his written request; said preferred stockholders to be notified of such proposed exchange as soon as the increase of the common stock shall have been effected, and their written request to be made and their option exercised within sixty days after such notice has been mailed. The Chairman of the Board then presented the following communication: To the BOARD or DIRECTORS of NORWICH METAL SPINNING COMPANY GENTLEMEN: Recognizing the disturbed industrial conditions now existing and the depress- ing effect this has had and is likely to have for some months to come on the business of the Norwich Metal Spinning Company, we, the undersigned executive officers of the Company, do hereby suggest and recommend that all salaries paid by the Com- pany be reduced as far as practicable, and that the operating expenses of the Com- pany be cut in every way consistent with real economy and the preservation of the organization, and, looking to this end, we hereby recommend that said reduction begin with the salaries of the executive officers of the Company, said salaries being reduced net less than 33^ per cent, and such reduction of salaries to continue in effect until the status of the Company justifies their reinstatement. Respectfully submitted, JOHN HARRISON PHILIP G. SANDERSON HENRY B. HORTON WILLIAM S. DICKENSON HOWARD DICKENSON After the reading of this communication, the following resolution was passed by the unanimous vote of all present: RESOLVED, That the salaries of the five executive officers of the Company John Harrison, Philip G. Sanderson, Henry B. Horton, William S. Dicken- son, and Howard Dickenson be reduced from Nine Thousand Dollars per annum to Six Thousand Dollars per annum, payable in monthly instalments of Five Hundred Dollars each, said reduction being effective from March i, 1922, and continuing until in the opinion of the Board the finances of the Com- pany justify the reinstatement of the executive salaries to their former figure. The Chairman of the Board reported that in accordance with the authoriza- tion already given, the Metal Polish Corporation had been formed under the laws of the State of New York with a capital stock of Five Hundred Shares of no par value; that all this stock had been issued to the Norwich Metal Spinning Company in payment for the patents, machinery, and equipment belonging to the Norwich Company and used in connection with the manufacture and sale of metal polish, and that in accordance with authority given them at the meeting of the Board of Directors of November 25, 1921, the officers of the Company had transferred the ownership of said patents, machinery, and equipment to the Metal Polish Cor- poration. Ch. 16] MINUTES OF MEETINGS 1567 Philip G. Sanderson, Treasurer of the Company, then called attention to the fact that the existing method of writing off depreciation on the machinery belong- ing to the Company was unsatisfactory in its operation, and asked authority to modify the present plan so that an arbitrary write-off of Fifteen Per Cent would be made annually, any corrections necessary to be made as to any particular mechanism at the time it was replaced or otherwise disposed of. Upon motion carried by unanimous vote of all present, the Treasurer was authorized to adopt this method of writing off depreciation. There being no further business before the meeting, it was adjourned. HENRY B. HORTON, WILLIAM S. DICKENSON, Secretary Chairman of the Board Part III Forms Relating to General Procedure SUBSCRIPTION AND ASSESSMENT NOTICES The following form of mailing notice is suitable when sub- scriptions to stock are payable in instalments as called for by the board. Form 174. Instalment Notice HILBERT DESK COMPANY 225 Main St., Grand Rapids, Mich. INSTALMENT NOTICE Mr. HOWARD BURNS, Sparta, Mich. DEAR SIR: You are hereby notified that by due resolution of the Board of Directors, an instalment of Ten Per Cent on subscriptions to the stock of this Company has been called for, the amount thereof to be paid to the Treasurer of the Company on or before the i5th day of January, 1922. HENRY H. HILBERT, Treasurer Grand Rapids, Mich., January 3, 1922 Shares subscribed, 25. Amount of Assessment, $250. Draw checks payable to Treasurer. i See also Ch. XII, "Notices of Meetings." 1569 1570 CORPORATE FORMS [Bk. IV- The following form of assessment notice may be used as 'either a mailing or publication notice. Form 175. Notice of Stock Assessment BURNS REFRIGERATING COMPANY ASSESSMENT NOTICE Notice is hereby given that assessment No. 2 of Fifteen Per Cent on the subscribed Capital Stock of this Company has been called for by due resolution of the Board of Directors, and is payable to the Treasurer of the Company on or before the i8th day of January, 1922. Newark, New Jersey, FRANCIS H. WILSON, December 15, 1921 Secretary Make checks payable to Treasurer. In some states the directors have statutory power to levy assessments under certain conditions. In several of the western states the statutes prescribe the form of notice for such assess- ments. This is substantially as follows: Form 176. Notice of Stock Assessment Statutory % RED GULCH MINING COMPANY Sacramento, California Notice is hereby given that at a meeting of the Directors held on the icth day of December, 1921, an assessment of Ten Dollars per share was levied upon the Capital Stock of the. corporation, payable on the i2th day of January, 1922, to the Treasurer of said Red Gulch Mining Company at its principal office, No. 584 J. Street, Sacramento, California. Any stock upon which this assessment shall remain unpaid on the 27th day of January, 1922, will be delinquent and adver- tised for sale at public auction, and unless payment is made before, will be sold on the nth day of February, 1922, to pay said delinquent assessment together with costs of advertising and expenses of sale. JOHN H. MCCLELLAND, Secretary December 10, 1921 This notice must be served upon each stockholder either personally or by mail, and must also be published, Ch. 17] MISCELLANEOUS NOTICES 1571 In case assessments are not paid when due, public notice must be given before the delinquent stock can be sold. A gen- eral form of assessment notice that may be used where the specific form is not prescribed by statute, is as follows: Form 177. Notice of Sale of Delinquent Stock BURNS REFRIGERATING COMPANY NOTICE OF SALE OF DELINQUENT STOCK Notice is hereby given that the undersigned, Treasurer of the Burns Re- frigerating Company, will on order of the Board of Directors and pursuant to the statutes in such case made and provided, sell at public auction on the 2nd day of June, 1922, at 2 o'clock in the afternoon at the office of the Company, 345 Broad St., Newark, New Jersey, Twenty (20) Shares of the stock of said Company now standing in the name of Howard T. Carle ton, or so many of said shares as may be sufficient to satisfy the unpaid assessment on said shares amounting to Three Hundred Dollars ($300), and also the interest thereon from the ipth day of Septem- ber, 1921, to the date of sale, and all necessary incidental charges. Fifty Dollars ($50) per share has already been paid the Company on said stock. HOWARD W. BRONSON, Treasurer Newark, N. J., May i, 1922 NOTICES RELATING TO DIVIDENDS In the smaller corporations dividend notices are usually sent only by mail. In the larger corporations they are almost invariably published and are usually also sent by mail. Form 178. Dividend Notice Mailing CHARLESTON MILLING COMPANY 78s~Grand St., New York December i, 1921 DEAR SIR: You are hereby notified that the Directors of the Charleston Milling Company have this day declared the regular semiannual dividend of Three Per Cent on the Capital Stock of the Company, payable January 15, 1922, to stockholders who appear of record at the close of business January 10, 1922. HARRY H. MCCALLUM, Treasurer 1572 CORPORATE FORMS [Bk. IV- If the transfer books are closed preparatory to payment of dividends, the dates of closing and reopening should appear as in the following notice, which may be used either for pub- lication or for mailing. Form 179. Dividend Notice Publication MARTIN FOUNDRIES COMPANY NEW YORK, February i, 1922 DIVIDEND No. 25 The Directors of the Martin Foundries Company have this day declared a quarterly dividend of One and One-Half Per Cent on the Capital Stock of the Company, payable March i, 1922, to stockholders of record at the close of business February 10, 1922. Transfer books will close February 10, 1922 and reopen February 20, 1922. Checks will be mailed. JOHN H. MARTIN Treasurer When notice of dividends is by publication alone, an explan- atory statement usually accompanies the dividend check. An announcement of this nature used by some of the larger cor- porations is given in the following form : Form 1 80. Notice Accompanying Dividend Check MARTIN FOUNDRIES COMPANY NEW YORK, March i, 1922 On February i, 1922, the Directors declared quarterly dividend No. 25 of One and One-half Per Cent upon the Preferred Stock of the Company, payable this day to stockholders of record of February 10, 1922. In accordance with permanent order on file, enclosed please find check for above dividend on the Preferred Stock standing in your name. No acknowledg- ment is necessary. Kindly advise John J. Hart, Assistant Secretary, No. 575 Broadway, New York, of any change in your address, giving your old address as well as the new. JOHN H. MARTIN, Treasurer Dividend check enclosed which please cash immediately. Ch. 17] MISCELLANEOUS NOTICES 1573 The following publication notice is somewhat informal but sufficient. Form 181. Dividend Notice THE CORN EXCHANGE BANK New York At a regular meeting of the Board of Directors of The Corn Exchange Bank held January n, 1922, a quarterly dividend of $5.00 per share was declared, pay- able February i, 1922, to stockholders of record at the close of business January 31, 1922. EDWARD S. MALMAR, Cashier This notice is signed by the cashier of the corporation. Usually, though not necessarily, dividend notices are signed by the treasurer. Form 182. Dividend Notice Common Stock OFFICE OF AMERICAN DREDGING COMPANY No. 145 BROADWAY, NEW YORK CITY, April 4, 1922 QUARTERLY COMMON STOCK DIVIDEND No. 23 The Directors of the American Dredging Company have this day declared a dividend of Two Per Cent on the Common Capital Stock of the Company, payable May 15, 1922, to stockholders of record April 28, 1922. The books of the Com- pany for the transfer of Common Stock will be closed at 3 P.M., April 28, 1922, and will be reopened May 2, 1922. M. W. ERICKSON, Treasurer The following publication notice covers the dividend on both common and preferred stock. This inclusion is not in any way objectionable, but at tim^s, for the sake of greater emphasis and publicity, a separate notice for each dividend is preferred. 1574 CORPORATE FORMS [Bk. IV- Form 183. Dividend Notice Common and Preferred Stock AMERICAN RADIATOR COMPANY PREFERRED DIVIDEND COMMON DIVIDEND A dividend of one and three-quarters per cent., being the 92nd consecutive quarterly dividend, has been declared on the Preferred Stock, payable February 15, 1922, to stockholders of record close of business February i, 1922. A dividend of One Dollar per share, being the yoth consecutive quarterly dividend, has been declared on the Common Stock, payable March 31, 1922, to stockholders of record close of business March 15, 1922. The Transfer Books will not close. WETMORE HODGES Secretary Form 184. Dividend Notice Mailing Orders Requested SOUTHERN NAVIGATION COMPANY DIVIDEND No. 95 A Quarterly Dividend of One Dollar and Fifty Cents ($1.50) per share on the Capital Stock of this Company has been declared payable at the Treasurer's Office, No. 165 Broadway, New York, N. Y., on July 2, 1922, to stockholders of record at 3 P.M., on Thursday, May 31, 1922. The stock transfer books will not be closed for the payment of this dividend. Cheques will be mailed only to stockholders who have filed permanent dividend orders. A. K. VAN DEVENTER, May 10, 1922 Treasurer The mailing order referred to in the foregoing dividend notice is shown below: Form 185. Mailing Order for Dividends No Check Mailed Without an Order To the TREASURER of SOUTHERN NAVIGATION COMPANY, 165 Broadway, New York, N. Y. Until this order shall be revoked in writing, please send by mail, in cheque payable to the order of See printed Address instructions. in (Please write Full distinctly.) all dividends now due, or which may hereafter become due, on all stock now stand- Ch. i7l MISCELLANEOUS NOTICES 1575 ing or which may hereafter stand, on the books of your Company in name. (Sign here (Date) exactly as name a P- pears on stock.) When payment is to be made to other than the stockholder, signature of the latter MUST be acknowledged before a Notary Public on the back of this order, and if signed by an Attorney, Administrator, Executor, Guardian or Trustee, it MUST be accompanied by satisfactory evidence of the signer's authority. On the back of this mailing notice appears form for notarial acknowledgment. NOTICES OF APPOINTMENT When an election is held, it devolves upon the secretary to notify the officials-elect. Form 186. Notice of Election as Director ORVELLE MACHINE WORKS Trenton, New Jersey January 10, 1922 Mr. GEORGE W. BROMLEIGH, 236 Greenwood Ave., Trenton, N. J. DEAR SIR: You are hereby notified that at the annual meeting of the Orvelle Machine Works held this day, you were elected a member of its Board of Directors. The next regular meeting of the Board will be held in the office of the Com- pany, February 5, 1922, at 3 P.M., for the election of officers and for the trans- action of such other business as may come before the meeting. You are requested to be present and participate in that meeting. Respectfully, MARTIN B. HEREFORD, Secretary Usually before the election of a director, those interested assure themselves that he will serve if elected. In such case the notification need not ask his acceptance of the position. If, however, there is any uncertainty, the notification of election should request a formal acceptance of the position. If the 1576 CORPORATE FORMS [Bk. IV- director-elect refuses to accept, his election is void, as he cannot be forced into office against his will. Form 187. Notice of Election as Director Acceptance Requested BLACK DIAMOND DRILL COMPANY 23 State St., Boston, Massachusetts January 10, 1922 Mr. HORACE H. FLEMING, 1716 State St., Boston, Mass. DEAR SIR: At a meeting of the Directors of this Company held this loth day 6f January 1922, you were elected a member of the Board to fill the vacancy caused by the death of Mr. Frederick Colwell. Will you kindly indicate your acceptance of the position at your early convenience. Respectfully, HOWARD B. IVES, Secretary As a rule, when corporate officials are elected, either the officers-elect are present at the meeting at which their election occurs, or are in such close personal touch with the corporate proceedings that formal notice of their election is unnecessary. If, however, a stranger is elected or appointed to an official corporate position, notice must be given. Form 188. Notice of Appointment as General Manager WILLIS OIL WELL COMPANY 265 Madison Avenue, New York January 17, 1922 Mr. HENRY P. SIMPSON, 445 Greenwood Ave., Newark, New Jersey DEAR SIR: At a meeting of the Board of Directors of this Company held this day, you were appointed General Manager of the Company at a salary of Forty-Eight Hundred Dollars per annum, payable in monthly instalments of Four Hundred Dollars each, your employment and duties to begin on the ist day of February, 1922, and the first instalment of your salary to be due and payable on the loth day of the following month. Ch. 17] MISCELLANEOUS NOTICES 1577 Will you kindly notify me without delay of your acceptance of the position and report for duty on the day above designated. Yours very truly, GERALD E. CONWAY, Secretary If the acceptance of the party elected is doubtful, his appoint- ment and the notice thereof are usually made tentative as in the following example. Form 189. Tender of Position as Sales Manager HOWARD DESK COMPANY 25 Stone St., New York December 10, 1921 Mr. WILLIS H. WALTERS, 225 Broadway, New York. DEAR SIR: I am instructed by the Board of Directors to tender you the position of Sales Manager of this Company at a salary of Six Thousand Dollars per annum, payable in monthly instalments of Five Hundred Dollars each, your employment and duties to begin in case of your acceptance, on the 3d day of January, 1922. Your early action in the matter will greatly oblige, Yours very truly, SHERWIN F. HAMILTON, Secretary CHAPTER XVIII RESIGNATIONS Resignations may be divided into two general classes those which are so phrased as to be effective without an acceptance, which may be termed peremptory resignations, and those which are tentative in their nature and therefore not effective until accepted. The following form is of the latter nature. Form 190. Resignation of Director To the BOARD OF DIRECTORS of the HOWARD SCALE COMPANY GENTLEMEN: On account of my continued ill health, which prevents my proper attention to the duties of the position, I hereby tender my resignation as a member of your body. Very respectfully, HENRY H. GALE New York City, January 10, 1922 If a resignation of this kind is accepted without qualification, its effect is immediate and the resigning director, though present at the meeting, ceases to be a director at the moment the resolu- tion or motion of acceptance is adopted. If it is desired to avoid this, acceptances may be phrased "to take effect at the close of the meeting." It may be noted in this connection that a director retiring by resignation cannot legally vote on his own successor. The vacancy does not exist until his resignation is effective and thereafter he is not a director. Dummy directors are sometimes elected to fill a position or vacancy in the board until a permanent incumbent is elected. In such case the dummy director's resignation in tentative form 1578 Ch. 18] RESIGNATIONS 1579 is usually secured at the time of his election and is placed on file. Then when a suitable person for permanent director has been found, the resignation on file is accepted and the successor is at once elected. The following form of resignation is commonly used under such circumstances. Form 191. Resignation of Director Effective on Acceptance To the BOARD OF DIRECTORS of the HARVARD PUBLISHING COMPANY GENTLEMEN: I hereby tender my resignation as a member of your body, to take effect upon acceptance. Respectfully, FRANK MCCLELLAND New York City, March i, 1922 This resignation holds good until acceptance or until the party's term as director expires, unless sooner withdrawn. If the party is again elected as a director, his old resignation is of no further effect and must be renewed if his same uncertain ten- ure of office is to be maintained. It must be remembered, how- ever, that a party tendering such a resignation has the right to withdraw it or to revoke it at any time prior to its acceptance. The final clause of the foregoing resignation, while con- ventional, is of no direct effect. A "tendered" resignation can- not take effect until accepted. The following form terminates the official status of the party signing the same as soon as the document is filed with the secre- tary of the company. No action of the board is required nor can the board in any way prevent its effect. This peremptory form of resignation is often employed in cases where a director wishes to escape responsibility for some proposed action of the board or wishes to express his disapproval of some action already taken. It does not in any way relieve him from responsibility for past actions but does relieve him from responsibility for any future board actions. 1580 CORPORATE FORMS [Bk. IV- Form 192. Resignation of Director Peremptory To the BOARD OF DIRECTORS of the FRANKLIN ELECTRIC CORPORATION GENTLEMEN: I hereby resign my position as a director of the Franklin Electric Corporation, my resignation to take immediate effect. Respectfully, WILLIAM H. COLLINS New Brighton, Pa., January 21, 1922 A resignation may be made effective at a future date as in the following form. The object of such a deferred resignation is usually to give time for the selection of a suitable successor. Form 193. Resignation of Director Future Date To the BOARD OF DIRECTORS of the COOPERSTOWN TANNERY GENTLEMEN : I hereby resign my membership in your body, such resignation to be effective May 21, 1922. Respectfully, HOWARD McCALL Cooperstown, New York, May i, 1922 When, as occasionally happens, some difficulty has arisen between the directors and an official, and this latter wishes a vote of confidence or an expression of the feeling of the board towards him, he will hand in a tentative resignation as in the form given below. If a majority of the board wish to retain the president, they either vote that the resignation be not accepted or vote against a motion for its acceptance. In either case the president's resignation is of no effect and the incident is merely an indorse- ment of him and his position. If, however, those opposed to the president are in a majority and accept the resignation, his official connection with the company is peremptorily terminated. Ch. 18] RESIGNATIONS 1581 Form 194. Resignation of President Conditional To the BOARD OF DIRECTORS of the STANDARD MILLING COMPANY GENTLEMEN : I hereby tender my resignation as President and Director of your Company and request your immediate action thereon. Very respectfully, HENRY H. MAXWELL Franklin, Pa., January 21, 1922 A more friendly resignation is given in the following form. Form 195. Resignation of Treasurer NEW YORK, June 28, 1922 To the BOARD OF DIRECTORS of the OTIS MACHINE COMPANY, 43 Dey St., New York GENTLEMEN: I am offered the position of Treasurer of the Los Angeles Fruit Company of Los Angeles, California, and on account of the condition of my health am very desirous of accepting the same. Therefore, I hereby tender my resignation as Treasurer of the Otis Machine Company and ask your acceptance of same at the earliest possible date. I would also request the early appointment of a committee to audit my accounts; also the due authorization of my successor to take over and receipt for the moneys and other property of the Company now in my charge. Regretting the termination of my pleasant official relations with the Company and thanking you for the uniformly kind consideration accorded me by your body, I remain, Respectfully, JAMES H. MCDONALD Resignations and other communications for the board of directors are frequently addressed to the secretary or even to the president of the .company. The better practice is to address the communication to the board, enclosing it in an envelope addressed to the secretary or the president of the company, as the case may be. It is then the duty of the officer receiving the communication to present it to the board. Such service on, or delivery to, the president or secretary is legally sufficient. CHAPTER XIX CORPORATE AND OFFICIAL SIGNATURES The signature of a corporate official followed by his official designation is usually referred to as an "official" signature. The name of a corporation duly affixed and evidenced by the signature of the affixing officer or officers is known as a "corporate" signature. Speaking generally, the corporate signature is affixed to all important instruments by which the corporation itself is to be directly and legally obligated, while the official signatures are employed by the corporate officials in matters pertaining par- ticularly to their respective departments, in which the contract relations of the corporation do not enter in, or, if otherwise, the authority of the officer signing the contract is sufficient to sustain his action. Thus, the president signs reports, letters, instruments, etc., with his official signature ; the treasurer signs notices of dividends or assessments, financial statements, and even corporate checks and reports in the same manner; while the secretary affixes his official signature to the minutes of meetings, to reports, notices, certificates, etc. In regard to letter signatures, practice varies widely. In perhaps the majority of corporations the qorporate signature is attached to every letter pertaining to the business of the corpora- tion unless there is some special reason for a different signature. In many corporations, however, this practice is exactly reversed, the official signature of the writer being always employed unless there is some special reason for the corporate signature. The former is the preferable plan. 1582 Ch. 19] CORPORATE AND OFFICIAL SIGNATURES 1583 Form 196. Official Signature Informal HOLLISTER PIANO COMPANY 63 State Street, Chicago, 111. January 3, 1922 Mr. WILLIAM HOLCOMB 155 Broadway, New York DEAR SIR: Your offer to supply this Company with mahogany veneer has been accepted- The matter will be formally closed as soon as the necessary papers can be prepared. Yours very truly, JOSEPH H. MCPHERSON, President This is the simplest form of official signature. It should be used only when the letter or other instrument to which it is appended shows plainly and unmistakably, by heading or subject matter, of what company the person signing is an official. If this is not the case, the official signature should be written in full as in the following form : Form 197. Official Signature Formal JOSEPH H. MACPHERSON President HOLLISTER PIANO Co. The corporate signature is shown below in its simplest form. Form 198. Corporate Signature Informal (1) RAMSAY WATER COMPANY, By President (2) RAMSAY WATER COMPANY', By Howard Ramsay, President The first of these forms shows a partial corporate signature usually affixed by means of a rubber stamp awaiting completion 1584 CORPORATE FORMS [Bk. IV- by the insertion of the president's signature as shown in the second form. The word "By" as given in the preceding form is sometimes omitted from the corporate signature. The word is, however, employed by a majority of the best conducted corporations of the country and its omission-may, under some circumstances, involve the officer whose name is affixed in a personal liability. i The form as given is therefore regarded as distinctly preferable. When the corporate signature is affixed to important instru- ments, usually, though not necessarily, two or more official signatures are employed. The seal is also usually affixed even when not legally necessary. It is to be remembered that seals were used before signatures and for many years corporations used seals, unaccompanied by written signatures, in attestation of their acceptance of the instruments to which their seals were affixed. Form 199. Corporate Signature Formal WESTERN CHEMICAL COMPANY, By JOSEPH H. MCCLEARY, / CORPORATE \ President \ SEAL / FREDERICK WELLMAN, Secretary The corporate signature may be legally affixed by any corporate official or agent authorized thereto by the directors or by-laws. In all current business, however, where but one signing officer is desired, the president is usually designated, unless the transaction pertains specially to the department of some other official. When the secretary's name is employed in a corporate signature, as in the foregoing form, no specific attestation of the seal is usual or necessary. If otherwise, the seal should be formally attested as in the following form which gives the corporate signature usually employed. 1 See comment on Form 217. Ch. 19] CORPORATE AND OFFICIAL SIGNATURES 1585 Signatures affixed to formal instruments are customarily preceded by an explanatory statement termed a "testimonium clause." Common forms of testimonium clauses follow. Form 200. Testimonium Clauses Corporate Signature Seal Attested (1) IN WITNESS WHEREOF, the said Powell Steel Company has caused its corporate name to be hereunto subscribed by its President and its duly attested corporate seal to be hereunto affixed by its Secretary, all in the City of Hartford, State of Connecticut, on the 1 2th day of January, 1922. / CORPORATE \ POWELL STEEL COMPANY, \ SEAL } By ALEXANDER H. MCDOWELL, President Attest seal: FRANKLIN B. LORD, Secretary (2) IN WITNESS WHEREOF, the said corporation has hereunto affixed its corporate signature and seal, acting through its President and Treasurer, duly authorized thereunto, all being done in the City, County, and State of New York, this ist day of February, 1922. HORLICK CARPET CORPORATION, By HOWARD HORLICK, / CORPORATE } President \ SEAL / WILLIAM JOHNSON, Secretary Form 201. Testirnoniurn Clause Two Corporate Signatures IN WITNESS WHEREOF, the said parties of the first and second parts have caused their respective corporate signatures and seals to be hereunto affixed by their duly authorized officers, in the City, County, and State of New York, on the day and year first above written. ( CORPORATE \ . ARLINGTON BRASS WORKS, \ SEAL J By HENRY BRIERLY, President Attest seal: JOHN H. SAVAGE, Secretary ( CORPORATE 1 NEWARK CASTINGS COMPANY, \ SEAL / By HORACE D. POWERS, President Attest seal: HENRY M. SUNTHEIN, Secretary 1586 . CORPORATE FORMS [Bk. IV- The foregoing is a convenient form of testimonium clause when the instrument is to be signed by two or more corporations. An informal but effective testimonium clause for a corporate and individual signature is as follows : Form 202. Testimonium Clause Corporate and Individual Signatures IN WITNESS WHEREOF, the parties hereunto have affixed their legal signatures and seals, all being done in the City of Trenton, State of New Jersey, on this 3rd day of January, 1922. f CORPORATE \ TRENTON CHAIN COMPANY, \ SEAL / By HOWARD MARKHAM, President Attest seal: HENRY JORDAN, Secretary JOHN H. PATTERSON [L. s.] A more formal testimonium clause for a corporate and in- dividual signature is given below : Form 203. Testimonium Clause Corporate and Individual Sig- natures IN WITNESS WHEREOF, the Little Falls Carpet Company, said parly of the first part, has caused its corporate seal to be affixed to this indenture and its corporate signature to be subscribed hereunto by its President and Secretary duly authorized thereunto, and the said Harrison H. Spellman, party of the second part, has affixed his signature and seal hereunto, all being done in the City of Trenton, State of New Jersey, on the day and year first above written. / CORPORATE "1 LITTLE FALLS CARPET COMPANY, \ SEAL / By WILLIS H. SHELLEY, President JAMES H. MCCLELLAND, Secretary HARRISON H. SPELLMAN [L. s.] If a contract is signed by an agent, the corporate seal is not usually affixed. Ch. 19] CORPORATE AND OFFICIAL SIGNATURES 1587 Form 204. Testimonium Clause Signature by Agent IN WITNESS WHEREOF, the said Milton Smelting Corporation, party of the* first part, acting through its duly appointed agent, Mortimer H. Shepherd, authorized thereunto by resolution of its Board of Directors (certified copy of which resolution under the corporate seal is hereunto annexed), has caused its corporate signature to be hereunto affixed, and Samuel Jaros, party of the second part, has hereunto affixed his signature and seal, all on the day and year first above written. MILTON SMELTING CORPORATION, By MORTIMER H. SHEPHERD, t A gent SAMUEL JAROS [L. s.] A copy of the resolution which authorizes the agent to execute the instrument on behalf of the corporation, duly certified under the corporate seal, should be attached to the signed instrument. CHAPTER XX CHECKS, RECEIPTS, AND NOTES CORPOEATE CHECKS The form of signature to a corporate check is not material. Its purpose is merely to identify and authenticate the instru- ment, and any signature duly prescribed by the by-laws or by resolution of the directors and recognized by the company's bank is sufficient. Consequently, while the corporate signature is usually to be preferred, there is in practice much variation as shown in the forms which follow. The corporate seal is seldom if ever used on corporate checks, though its use does not affect the check in any way. When the corporate funds are material in amount, the names of two officials, the president and treasurer, are usually required upon the check. The forms of corporate checks which are given below are in common use. Form 205. Check Corporate Signature I ^ ^ of the City of New York < Q 5 No. 1754 NEW YORK, May i, 1922 SEABOARD NATIONAL BANK Pay to the order of John H. Wilkins $425.75 Four Hundred and Twenty-five 75/100 Dollars STANDARD RADIATOR COMPANY, SAMUEL S. STEIGEL, President STEWART H. WILSON, Treasurer 1588 Ch. 20] CHECKS, RECEIPTS, AND NOTES . 1589 Frequently the number is placed in the upper right-hand corner of a check, the date line coming in above or below. Such an arrangement, with the other details as shown in the form given, is highly approved by bank officials, as it brings the essential features of the check number, date, amount, payee, and signature all well over to the right-hand side of the check in the position that is most convenient for rapid reference. If the by-laws or a directors' resolution require that the corporate name be affixed by the treasurer and the check be countersigned by the president of the company, as is frequently found to be the case, the following is an approved form of such a check, u nr. Form 206. Check Countersigned ~ "" No. 244 NEW YORK, June 8, 1922 J z STANDARD NATIONAL BANK of the City of New York Pay to the order of Howard P. Huntington $475.00 Four Hundred and Seventy-five no/ioo. Dollars. Countersigned: MERRIVALE COAL COMPANY, JAMES J. McLANE, By HORACE P. WISNER, President Treasurer _ Form 207. Check Official Signatures XT Q XT T7 T No. 1582 NEW YORK, January 3, 1922 THE PEOPLE'S NATIONAL BANK of New York Pay to the order of Jesse Claire $125.45 One Hundred and Twenty-five 45/100 Dollars. WALLACE McCoMB, PERRY H. DUCROIX, President Treasurer . 1590 CORPORATE FORMS [B|>. IV- Form 208 Check Official Signatures Purpose Stated .fi d * No. 745 NEW YORK, May i, 1922 BANK OF MANHATTAN of New York City Pay to the order of James & Oliver $125.75 One Hundred and Twenty-five 75/100 Dollars RUDOLF HESSLER, President In full for September printing. JASPER H. McMEis, Treasurer Where the official signatures of the treasurer and the president are affixed, the form is usually as above. There is no objection, legal or practical, to the entry on a check of the purpose for which it is issued, if so placed as not to obscure or interfere with its essential details. The advantage in the use of such a check is apparent. Duly indorsed, as it must be before payment is made, the check itself affords the best possible evidence of the settlement effected thereby, and saves the expense and trouble of a more formal receipt. A form of check much in favor because of the prominence given to the name of the issuing corporation, is as follows: Form 209. Check Draft Form ALLIS-WILKINS COMPANY 1675 Broadway, New York No. 1728 March 10, 1922 Pay to the order of Jesse H. Sinclair $35-25 Thirty-five 25/100 Dollars. ALLIS-WILKINS COMPANY, By FRANCIS H. WHITMAN, Treasurer To the SEABOARD NATIONAL BANK, New York Ch. 20] CHECKS, RECEIPTS, AND NOTES 1591 In the smaller corporations dividends are usually paid by means of the ordinary corporate check, the words "Dividend Check" being stamped or written across its face. In the larger corporations special checks are employed for the purpose, as in the following form: Form 210. Dividend Check AMERICAN WOOL EXPORT COMPANY New York, February 3, 1922 No. 1482 AMERICAN NATIONAL BANK of New York Pay to the order of Henry H. McCall $125.00 One Hundred and Twenty-five 00/100 Dollars. Countersigned: STOCK TRANSFER DEPARTMENT, FRANK S. JORDAN, JOHN FRENCKEL, Transfer Agent Treasurer No receipt is usually required when this form of dividend check is employed, the duly indorsed check in itself affording the best possible evidence that payment of the dividend has been made. The ordinary indorsement of a corporate check is given in the following form: Form 211. Indorsement of Corporate Check 33 " 1592 CORPORATE FORMS [Bk. IV- This indorsement is usually affixed by the treasurer or cashier, though the president is frequently authorized thereto. The following form of indorsement is usually affixed in its entirety corporate name, official signature, and all with a rubber stamp. Such an indorsement is approved by the banks and, on account of the rapidity and convenience with which it may be affixed, is generally employed. Form 212. Indorsement of Check for Deposit 'A s The following is a common form of corporate draft, signed by one official. ..; Form 213. Corporate Draft _ _ __ No. 745 'NEW YORK, May 15, 1922 Three days after sight pay to the order of Seaboard National Bank of New York $1,245.25 Twelve Hundred and Forty-five 25/100 Dollars payment of account as per our statement of April 10, 1922. Value received. Charge same to account of CAR EQUIPMENT COMPANY, By HOWARD JAMES, Treasurer To NORTH WHEELING CAR Co., Wheeling, West Virginia Ch. 20] CHECKS, RECEIPTS, AND NOTES 1593 CORPORATE RECEIPTS J A common form of corporate receipt is as follows: Jljlvl Form 214. Corporate Receipt $250.00 NEW YORK, July 15, 1922 Received from Edward M. Blair Two Hundred and Fifty Dollars, rental of Store at No. 65 Vesey St. for the month of July, 1922. METROPOLITAN REALTY COMPANY, By SAMUEL F. WATKINS, Treasurer It would seem preferable that all receipts foremoney received by a corporation should be given in the corporate name. In practice, however, corporate receipts are commonly signed by the treasurer. In such case the name of the corporation should appear prominently. Form 215. Corporate Receipt Official Signature : $725.25 March 15, 1922 WELLMAN SUPPLY CORPORATION 265 Chambers St., New York Received from the Jackson Hardware Company Seven Hundred and Twenty- five 25/100 Dollars in full of account. H. J. ASHTON, Treasurer _ _ The larger corporations, when dividends are to be paid, employ dividend checks, which, when properly indorsed and deposited, are usually regarded as all-sufficient receipts. It is easy to devise some form of voucher check which will satis- factorily meet the situation. 1 See Forms 73, 74, for receipts for instalment payments 1 594 CORPORATE FORMS 'Bk. iv- If, however, formal receipts are desired, the following form will serve: Form 216. Dividend Receipt $25.00 BOSTON, MASS., March i, 192 Received of the Howard Foundation Company Twenty-five Dollars, payment in full of quarterly dividend No. 37, of One and One-half Per Cent on the stock of said corporation standing in my name HENRY J. POLLOCK . i This receipt is sent out with the dividend check to be signed and returned by the recipient. When payment of dividends is made at the office of the company or at the office of some specified trust company or bank, the parties receiving payment usually sign the dividend register and no other receipt is necessary. CORPORATE NOTES A corporate note does not require to be sealed. It may be signed by any officer or officers properly authorized thereto. Such authority is usually conferred by by-law provisions or by resolution of the board of directors, but otherwise may be given by custom. For large amounts or special trans- actions outside the usual routine, the officer's authorization should always be specific and usually by resolution of the board of directors. In such cases the parties accepting the corporate note will usually require a certified copy of the resolution author- izing the issuance of the note. The signature of a corporate note should always be the corporate signature. Any other signature may not only fail to bind the corporation, but has been held in some states to involve the official signing the note in a personal liability as its maker or indorser. Ch. 20] CHECKS, RECEIPTS, AND NOTES 1595 Form 217. Corporate Note By President $500.00 NEW YORK, April 5, 1922 Ninety days after date the Hillman Dredging Company promises to pay to the order of Howard P. Hunt the sum of Five Hundred Dollars. Value Received. HILLMAN DREDGING COMPANY, By NATHANIEL POTTER, President Payable at IRVING NATIONAL BANK, New York - ~ ~ - Form 218. Corporate Note By Treasurer $2,500.00 BOSTON, MASS., December i, 1921 Four months after date the Hanover Securities Company promises to pay to the order of James C. Bennett the sum of Twenty-five Hundred Dollars, with interest from date until paid, at the rate of Six Per Cent per annum, at the Sedgwick National Bank of Boston. Value Received. HANOVER SECURITIES COMPANY, By WILLIAM CURTISS, No. 725 Treasurer Due April i, 1922 The preceding notes are in the simplest form. The corporate signature is affixed by one officer or by two as may be customary or required by by-law provision or directed by the board. Form 219. Collateral Note On Demand COLLATERAL NOTE $4,000.00 NEW YORK, February 3, 1922 ON DEMAND the Hanover Power Company promises to pay to the Seaboard National Bank of the City of New York, or order, at its Banking House, No. 18 Broadway, New York, N. Y., Four Thousand Dollars ($4,000) for value received, with interest at the rate of Six Per Cent (6%) per annum from the date hereof, said corporation having deposited with said Bank as collateral security for payment of this or any other liability or liabilities of the undersigned to said Bank, due or to be due or which may be hereafter contracted or exist, the following property or securities, viz.: Seventy-five (75) Shares of the Preferred Stock of the United 1506 CORPORATE FORMS [Bk. IV- States Steel Corporation of the par value of One Hundred Dollars ($100) each, the certificate for said stock standing in the name of John H. Howard, Treasurer of the said Hanover Power Company, and being indorsed by him in blank on the back of said certificate. The market value thereof is today $6,225, ar >d full power and authority is hereby given to said Bank to sell, assign, and deliver the whole or any part thereof, or any substitutes therefor, or any additions thereto, at any Brokers' Board, or at public or private sale, at the option of said Bank or its assigns on the non-perform- ance of this promise or the non-payment of any of the liabilities above mentioned, or at any time or times thereafter, without advertisement or notice, which are here- by expressly waived; and upon such sale the holder hereof may purchase the whole or any part of such securities discharged from any right of redemption, and after deducting all legal or other costs and expenses for collection, sale and delivery, shall apply the residue of the proceeds of such sale or sales so to be made to pay any, either, or all of said liabilities to said Bank or its assigns as said Bank or its assigns shall deem proper, returning the overplus, if any, to the undersigned. And the undersigned gives to said Bank a lien to secure this note.-and all said other liabilities now existing or hereafter arising, and whether at any time due or not upon all property and securities of the undersigned now or hereafter deposited with or left in the possession of said Bank, either as collateral for any other obligation or otherwise, and also upon any balance at any time of the deposit account of the undersigned with said Bank. Other collaterals may be substituted or added from time to time with the bank's consent, all representations, conditions, and agree- ments as to original collaterals applying to those so substituted or added. IN WITNESS WHEREOF, the said corporation has hereunto affixed its corporate signature and seal, acting through its President and Treasurer duly authorized thereunto. fcoRPORATE\ HANOVER POWER COMPANY, \ SEAL / By JOHN H. HENDERSON, President HARRY F. SINCLAIR, Treasurer Another form of collateral note is as follows: Form 220. Corporate Note Collateral Security COLLATERAL NOTE $10,000.00 NEW YORK, January 15, 1922 Ninety days after date, the Berwick Mercantile Company promises to pay to the order of the Guardian Trust Company of New York City, at No. 170 Broadway, New York City, the sum of Ten Thousand Dollars ($10,000), with interest from date until paid at the rate of Six Per Cent (6%) per annum, and the said Berwick Mercantile Company doth herewith deposit with the Guardian Trust Company as collateral security for the due payment of the foregoing promissory note, Two Hundred (200) Shares of its stock in one Certificate No. 325, said Certificate stand- ing in the name of Mark Baldwin, Treasurer of the said Berwick Mercantile Com- pany, and indorsed by him in blank. And in the event that this note or the interest thereon shall not be paid when due, the said Berwick Mercantile Company hereby appoints and constitutes the Ch. 20] CHECKS, RECEIPTS, AND NOTES 1597 said Guardian Trust Company its attorney in fact and irrevocably, with power of substitution, to sell at any time after this said note or any interest thereon is due and unpaid, with or without notice, and either at public or private sale, the whole or any part of said securities, the proceeds thereof to be applied to the payment of the said promissory note, any interest due thereon, and any commissions properly payable on the sales of said securities so sold, and any surplus remaining thereafter, either of cash or of the said securities to belong to and be subject to the order of the said Berwick Mercantile Company; and should said securities not bring the full amount of this present note, together with any interest accrued thereon, said Berwick Mercantile Company undertakes and agrees to pay the amount still due to the holder hereof on demand. Should any such sale be made, the holder hereof shall directly or in the name of any other person, have the right to purchase the security aforesaid. In case the market value of the same shall decrease, the said Berwick Mercantile Company hereby promises and agrees to proportionately reduce the amount of its indebted- ness hereunder, or otherwise increase the security in proportion to said decrease of value. IN WITNESS WHEREOF, the said Berwick Mercantile Company has caused its name to be subscribed hereunto by its President, and its duly attested seal to be affixed hereto by its Secretary, on the day and year first above written. ("CORPORATE 1 BERWICK MERCANTILE COMPANY, \ SEAL / By HENRY S. CORBIN, President Attest seal: AMOS C. HALLOCK, Secretary neQ CHAPTER XXI CERTIFICATIONS The certifications so frequently required in corporate pro- cedure are never made in the corporate name. Certificates and affidavits to corporate instruments are made over their own names by the officers directly concerned. Acknowledgments are made for and on behalf of the corporation but not in its name by such corporate officials or agents as may be prescribed by statute or be authorized thereto by the by-laws or resolutions of the board. The following is a simple form of certificate to service of notice, more especially to service of notice of a corporate meeting. Form 221. Certificate to Service of Notice I, the undersigned, Secretary of the Atlantic Machine Works, do hereby certify that in accordance with the by-law requirements of said Company, a copy of the foregoing notice, properly enclosed and directed, and with postage prepaid, was by me on the 2ist day of December, 1921, mailed to each stockholder of record of said Company at his address as it appeared on the books of the Company. HENRY H. LINDEN New York City, January 3, 1922 This certificate usually appears on the same sheet with, and below a copy of, the notice, though sometimes written separately and attached to a copy of the notice. In this latter case the wording of the certificate must be changed to correspond with the facts. An affidavit, as in the case of the certification, may appear on the same sheet as the copy of the notice, or be attached thereto. 1598 Ch. 21] CERTIFICATIONS 1^99 Form 222. Affidavit to Service of Notice STATE OF NEW YORK \ . COUNTY OF NEW YORK / On this 3rd day of January, 1922, before me personally appeared Henry H. Linden, Secretary of the Atlantic Machine Works, who being duly sworn, did depose and say that on the 2ist day of December, 1921, a copy of the attached notice of meeting, properly enclosed and directed and with postage prepaid, was by him mailed to each stockholder of record of said corporation at his address as shown by the books of the Company. HENRY H. LINDEN Sworn to and subscribed before me the day and year aforesaid. JOHN H. ANDERSON, / NOTARIAL \ Notary Public for \ SEAL / County of New York, No. 1 6 The best evidence of notice by. publication is furnished by complete copies of the papers in which the notice appeared. When these are supplied, no certification as to publication of the notice is usually required. If, however, the notice is clipped from' the paper and so preserved, an affidavit is sometimes con- sidered desirable. The larger city papers, on request, furnish affidavits of publication for notices appearing in their columns. Form 223. Affidavit to Publication of Notice STATE OF NEW YORK 1 . COUNTY OF NEW YORK / On this 3rd day of January, 1922, before me personally appeared Henry H. Linden, Secretary of the Atlantic Machine Works, who being duly sworn, did depose and say that the annexed notice was published in the New York Times on the 22nd and 2916 days of December, 1921. HENRY H. LINDEN Sworn to and subscribed before me the day and year aforesaid. (Notarial acknowledgment as in Form 222.) In the following form of certified resolution the resolution appears on the upper part of the sheet followed by the certifica- tion, the general arrangement being the same as in Form 229. i6oo CORPORATE FORMS [Bk. IV- Form 224. Certified Resolution Designating Bank 1 (Resolution here.) I, Sherman H. Rogers, Secretary of the Allis Drug Company, do hereby certify that the foregoing is a full and true transcript of a resolution duly adopted at a regular meeting of the Board of Directors of the said Company held in the City of New York on the loth day of November, 1921, as it appears on the minutes of said meeting, and I do further certify that Charles Allis is the duly elected President of said Company, and Jasper T. Huntington is its duly elected Treasurer IN WITNESS WHERE.OF, I have hereunto affixed my official signature and the corporate seal of said Company, this 25th day of November, 1921. SHERMAN H. ROGERS, ( CORPORATE \ Secretary \ SEAL / The following certification is employed in connection with the resolution given in Form 145. Form 225. Certification of Resolution Designating Bank I, John H. Farwell, Assistant Secretary of the Standard Milling Company, do hereby certify that the foregoing resolution was duly adopted at a regular meeting of the Board of Directors of said Company held on Tuesday, February 7, 1922, in the office of the Company, 225 Fifth Avenue, New York, all as shown by the minutes of said meeting, and that the transcript of Section 3, Article VII, of the By-laws of said Company appearing in the preamble of said resolution is a true and accurate transcript thereof from the duly adopted By-laws of the Company, and I do further certify that Henry F. Farrand is the duly elected Treasurer of said Company and Howard C. Malcolm is its duly elected President. Witness my official signature and the corporate seal of said Company, this 1 8th day of February, 1922. JOHN H. FARWELL, ( CORPORATE \ Assistant Secretary \ SEAL / If the bank requires certified signatures of the signing officials, these signatures might be written on the same sheet between the resolution and certification, and the following phrase be added to the certification: "and that the signatures above written are respectively the signatures of the said Henry F. Farrand and Howard C. Malcolm." 1 See Forms 144-146. Ch. 21] CERTIFICATIONS 1 60 1 A different form of certification employed in connection with the resolution of Form 146 is as follows: Form 226. Certification of Resolution The undersigned, Secretary of the American Textile Company, does hereby certify that the foregoing resolution was duly adopted on the zoth day of January, 1922, at a meeting of the Board of Directors of said Company regularly called and duly constituted and at which a quorum was present. Witness my hand and the seal of said corporation this i2th day of January, 1922. ALFRED DILWORTH, f CORPORATE \ Secretary \ SEAL / Form 227. Certificate of Election of Treasurer I, Horace B. Elkins, Secretary of the Ellwood Creamery Company, hereby certify that at a regular and duly constituted meeting of the Board of Directors of said Company held in the City of Albany on the ist day of March, 1922, Henry Howells was elected Treasurer of said Company to fill the vacancy in said office caused by the death of J. J. McAllen, and that the said Henry Howells is now the duly qualified and authorized Treasurer of the said Ellwood Creamery Company Witness my hand and the seal of the Company this loth day of March, 1922. HORACE B. ELKINS, f CORPORATE \ Secretary \ SEAL / Form 228. Certificate of Election of Officers I, Emory Hardin, Secretary of the Dyett-King Leather Company, do hereby certify that the Directors of said Company being duly assembled in lawful meeting in the office of the Company, No. 75 Dey St., New York City, on the 9th day of March, 1922, and a quorum being present, did then and there elect Frederick Myers, President, and Walter C. Jackson, Treasurer of said corporation, to serve for the ensuing year and until the due election and qualification of their successors, and that said Frederick Myers and Walter C. Jackson are now duly and fully qualified and empowered to act for said corporation in their respective official capacities. IN TESTIMONY WHEREOF, I have hereunto affixed my official signature and the corporate seal of said Company this isth day of March, 1922. EMORY HARDIN, f CORPORATE \ Secretary \ SEAL / 1602 CORPORATE FORMS [r,k. IV- The foregoing certificate of the election of corporate officials may be used when greater formality is de.sired. Forms for certifications of transcripts of various kinds are given below. In the transaction of corporate business transcripts from the by-laws are frequently required. When the matter is of any considerable importance these transcripts must be certified. Form 229. Certification of Transcript from By-Laws CONSOLIDATED CRACKER COMPANY TRANSCRIPT FROM BY-LAWS "ARTICLE IV OFFICERS "Sec. 2. The President "The President when present shall preside at all meetings of the stockholders and of the Board of Directors; shall sign all certificates of stock; shall sign or countersign as may be necessary all such bills, notes, checks, drafts, and other instruments as may pertain to the ordinary course of the Company's business; and shall sign when duly authorized thereto all contracts, orders, deeds, licenses, and other instruments of a special nature. "He may also in the absence or disability of the Treasurer, indorse checks, drafts, and other negotiable instruments for deposit or collection, and shall with the Secretary sign the minutes of all meetings over which he presides." I, James T. Howard, Secretary of the Consolidated Cracker Company, do hereby certify that the above is a true and correct copy of Section 2, Article IV of the duly adopted by-laws of this Company, and in testimony thereof I have here- unto affixed my official signature and the seal of the Company, in the City of Brooklyn, on this 2ist day of March, 1922. JAMES T. HOWARD, CORPORATE \ Secretary SEAL / Form 230. Certification of By-Laws as a Whole I, the undersigned, Secretary of the General Auto Supply Company, do hereby certify that the foregoing is a true and complete copy of the By-laws of said corpora- tion, including all amendments, and as the same are in force, at the date hereof. IN WITNESS WHEREOF, I have hereunto subscribed my name and affixed the seal of said corporation, this 2nd day of March, 1922. WILLIAM H. SANFORD, f CORPORATE \ Secretary I SEAL f Ch. 21] CERTIFICATIONS 1603 The following is a convenient form when the transcript from the minutes of either stockholders' or directors' meetings must be certified. Form 231. Certification of Transcript from Minutes WESTON MANUFACTURING CORPORATION TRANSCRIPT FROM MINUTES OF REGULAR MEETING or DIRECTORS Held February 15, 1922 (Transcript from minutes appears here.) I, the undersigned, Secretary of the Weston Manufacturing Corporation, do hereby certify that the above and foregoing is a true and accurate transcript from the minutes of a regular meeting of the Board of Directors of said Company held in the office of the Company on the isth day of February, 1922, and recorded on pages 85 to 87 of the Minute Book of said Company. Witness my hand and seal of the Company this i4th day of April, 1922. HORACE POTTER, / CORPORATE } Secretary \ SEAL / The president occasionally joins with the secretary in the certification of any specially important transcript. In such case the certificate is changed as follows : Form 232. Certification of Minutes President and Secretary We, the undersigned, President and Secretary respectively of the Weston Manufacturing Corporation, do hereby certify that the above and foregoing is a true and accurate transcript from the minutes of a regular meeting of the Board of Directors of said Company held in the office of the Company on the isth day of February, 1 92 2, and recorded on pages 85 to 87 of the Minute Book of said Company. IN WITNESS WHEREOF, we have hereunto affixed our official signatures and the seal of the Company in the City of New York on this i4th day of April, 1922. HENRY J. RANDALL, ( CORPORATE \ President \ SEAL / HORACE POTTER, Secretary 1604 CORPORATE FORMS [Bk. IV- Affidavits take the place of the secretary's certificate when corporate records or transcripts therefrom are required for use in legal proceedings. Form 233. Secretary's Affidavit to Minutes STATE OF NEW YORK COUNTY OF NEW YORK On this i4th day of April, 1922, before me personally appeared Horace Potter, who being duly sworn, did depose and say that he is the Secretary of the Weston Manufacturing Corporation; that he was present at the regular meeting of the Directors of that Company held on the i5th day of February, 1922, that he recorded the proceedings of said meeting in the Minute Book of the corporation, and that the above and foregoing is a true and correct transcript from the minutes so recorded. HORACE POTTER Sworn to and subscribed before me on the day and year above stated. (Notarial signature and seal.) Notarial exemplifications of certified transcripts from the corporate records are sometimes required, as follows: Form 234. Notarial Exemplification of Minutes STATE OF NEW YORK COUNTY OF NEW YORK Personally appeared before me this i4th day of April, 1922, Horace Potter, to me well known, and acknowledged that he signed the foregoing certification of a transcript from the minutes of the Weston Manufacturing Corporation, and affixed the seal of said Company thereto as Secretary of the said Company for the purposes therein set forth, and I have personally examined the minutes of said Company under date of February 15, 1922, and certify that the foregoing transcript is correctly transcribed therefrom. MORRIS MANNING, {NOTARIAL } Notary Public for SEAL / County of New York, No. 765 Term expires December i, 1922. Form 235. Treasurer's Affidavit to Corporate Statement STATE OF NEW YORK 1 COUNTY OF NEW YORK J ss " On this 29th day of March, 1922, personally appeared before me, a Notary Public in and for the County of New York, Walter L. Hood, Treasurer of the Hood Ch. 21] CERTIFICATIONS 1605 Scale Company, who, being duly sworn, did depose and say that he has full charge and control of the books and accounts of the said Company; that the above and foregoing statement is taken from said books and accounts; that it is a true and accurate transcript therefrom, and that to the best of his knowledge and belief it is a just and correct presentation of the financial condition of said Company on this date. WALTER L. HOOD Sworn to before me the day and year aforesaid. JAMES H. STEELE, f NOTARIAL v Notary Public for \ SEAL } New York County, No. 994 Term expires Feb. 15, 1923. The treasurer's certifications to matters relating to the corporation's finances are usually in the form of affidavits. The affidavit should follow the statement on the same sheet or on the last sheet if the statement extends over several pages. When a corporate acknowledgment is taken, the notary should not be an officer or stockholder of the corporation. The form of acknowledgment is usually regulated by statute and therefore varies in almost every state. The following form of corporate acknowledgment is that prescribed by the statutes of New York. Form 236. Notarial Acknowledgment New York STATE OF NEW YORK \ COUNTY or NEW YORK / 55 " On this i6th day of March in the year 1922, before me personally came John J. Kerry, to me known, who, being by me duly sworn, did depose and say that he resided in the City of New York; that he is the President of the Kerry Machine Works, the corporation described in and which executed the above instrument; that he knew the seal of said corporation; that the seal affixed to said instrument was such corporate seal; that it was so affixed by order of the Board of Directors of said corporation, and that he signed his name thereto by like order. JOHN J. KERRY Sworn to before me the day and year aforesaid. (Notarial signature and seal.) CHAPTER XXII POWERS OF ATTORNEY, CONTRACTS, AND ASSIGNMENTS POWERS OF ATTORNEY The execution of a power of attorney varies according to the powers conveyed and the ccnditions under which it is given. The instrument which follows does not require acknowledgment if the parties signing the power of attorney are known to the corporate officials. If this is not the case a notarial acknowl- edgment is usually required. Form 237. Power of Attorney To Receive Dividends POWER OF ATTORNEY I, the undersigned, do hereby constitute and appoint George H. Williams of New York City, my true and lawful attorney, for me and in my place and stead to receive any and all dividends now due or which may hereafter become due on the Fifty Shares of Preferred Stock o . the Howard Bank Note Company now standing in my name on the books of said Company, and to receipt for the same, and to do all other things that may be necessary to enable him to receive my said dividends; and I hereby ratify and confirm all that my said attorney may properly do by virtue of the authority herein conferred. IN WITNESS WHEREOF, I have hereunto affixed my signature and seal this 7th day of January, 1922. GEORGE H. LANE [L. s.] Witnessed by: HOWARD LANSING A corporate power of attorney differs from the ordinary form only in those details directly incident to its corporate origin. It should either be accompanied by a certified copy of the resolution which authorizes it, or otherwise be acknowledged. 1606 Ch. 22] POWERS OF ATTORNEY 1607 Form 238. Power of Attorney To Collect Money POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS: That the Tucson Cattle Company, a corporation duly organized under the laws of Arizona, does hereby make, constitute, and appoint Howard H. McComb of the State of New York, its true and lawful attorney, for it and in its name, place, and stead to collect and receive from the New York Drovers' Association of New York City the sum of Three Thousand Dollars ($3,000) with interest thereon at the rate of Six Per Cent (6%) per annum from the ist day of January, 1922, said amount being due and payable to the Tucson Cattle Company for and on account of cattle shipped the said New York Drovers' Association during the month of December, 1921, and the said Howard H. McComb is hereby fully authorized and empowered for and on account of the said Tucson Cattle Company and in its name, to collect, receive, and receipt for the said Three Thousand Dollars ($3,000), and the interest thereon as aforesaid, in whole or in part, but without prejudice to any portion thereof unpaid, and to incur and pay on behalf of the said Tucson Cattle Company all reasonable expenses incident to the collection of said amount, includ- ing all proper costs of any suit or other legal proceedings necessary thereto, and generally to do all such other things in connection therewith as may be necessary and proper in the premises. IN WITNESS WHEREOF, the said Tucson Cattle Company has caused its corporate name to be signed hereunto by its President and its corporate seal to be affixed and attested by its Secretary, all being done in the City of Tucson, Arizona, on this the 2nd day of March, 1922. / CORPORATE \ TUCSON CATTLE COMPANY, \ SEAL j By GEORGE M. PRICE, President Attest seal: WILSON M. BUUNEY, ' Secretary The foregoing power of attorney would usually be ac- knowledged in order to give it greater weight and more ready recognition. Form 239. Power of Attorney To Deliver Deed POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS: That the Albany Flouring Mills, a corporation duly organized under the laws of the State of New York, and having its principal office and place of business in Albany, New York, has made, constituted, and appointed and by these presents does make, constitute, and appoint, George H. McCall of Philadelphia, Pennsyl- vania, its true and lawful attorney, for it and in its name and stead, to deliver to the 1608 CORPORATE FORMS [Bk. IV- Adams Foundation Company of Philadelphia, Pennsylvania, a certain deed duly executed by the said Albany Flouring Mills and transferring to the said Adams Foundation Company the property therein described at Nos. 1534, 1536, and 1538 West Side Avenue, Philadelphia, and to receive payment for the property trans- ferred by said deed; and the said George H. McCall is hereby fully authorized and empowered for and on behalf of this Company to make good and valid delivery of the said deed and to receive from the said Adams Foundation Company the sum of Nineteen Thousand, Two Hundred and Fifty Dollars ($19,250) in cash, payment for the property transferred by said deed, and to receipt for said payment, and to do all such other things as may be necessary and proper in the premises. IN WITNESS WHEREOF, the said Albany Flouring Mills has caused its corporate seal to be affixed hereunto by its Secretary and its name to be subscribed hereto by its President, all being done in the City of Albany, and State of New York, on this first day of February, 1922. f CORPORATE \ ALBANY FLOURING MILLS, \ SEAL / By JESSE H. BLANCHARD, President Attest seal: JULIAN HURNDON, Secretary (A cknowledgment) The power of attorney which follows authorizes the sale of land and the execution and delivery of the deeds, and therefore requires the same formal execution as a deed. Without this it is ineffective. The form of execution must comply with the law of the state in which the land is located. Form 240. Power of Attorney To Manage, Sell, and Deed Land POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS : That the Berwell Investment Company, a corporation duly organized and existing under and by virtue of the laws of the State of New York, and having its office and principal place of business at No. 30 Broad Street, in the City of New York, has made, constituted, and appointed, and by these presents does make, constitute, and appoint, Horace M. Maxwell of Houston, Texas, its true and lawful attorney, for it and in its name, place, and stead to bond, grant, bargain, sell, contract, lease, exchange, give options on, sell timber from, sell or lease oil, coal or other mineral rights in or on, or handle or dispose of in such other way as may by him be deemed advantageous and advisable, and for such considerations and on such terms as he may approve, and in whole or in part, that certain tract or parcel of land, owned by said Berwell Investment Company, in Brazos County, Texas, consisting of the east half of the league of land known as the J. J. Oliver League, and containing Two Thousand Two Hundred and Fourteen (2,214) Acres, more or less, said land being part of the Headright granted to J. J. Oliver by the Mexican Government and surveyed by the County Surveyor in 1838, and conveyed to the Ch. 22] POWERS OF ATTORNEY 1609 Berwell Investment Company by deed from the said J. J. Oliver, dated July i, 1856, and recorded in the office of the County Clerk of Brazos County, D. B. 15, page 225; and the said Berwell Investment Company grants to its said attorney full power and authority to collect and receive for said Company all rents, royalties, and other considerations or payments derived from the said property in any way; and for the said Berwell Investment Company and in its name and stead, either alone or jointly with others, as may be requisite and necessary, to make, execute, acknowl- edge, and deliver good and sufficient deeds, conveyances, option contracts or leases for the said property, or for any parts thereof, or for any rights therein or thereon, giving and granting its said attorney full power and authority to do and perform any and every act and thing whatsoever requisite and necessary to be done in the premises, the said Company hereby ratifying and confirming all that its said attorney shall lawfully do or cause to be done by virtue of this present indenture. IN WITNESS WHEREOF, the said Berwell Investment Company has caused its corporate name to be signed by its President and its corporate seal to be affixed by its Secretary, all being done in the City of New York on this the i8th day of January, 1922. CORPORATE \ RWELL INVESTMENT COMPANY, SEAL J By JAMES WARREN, President Attest seal: WILLIS BAKER, Secretary (A cknowledgmenf) This instrument is sweeping, giving the agent practically every power over the lands covered by the power of attorney, that the company has itself. The acknowledgment must in this case follow the Texas form. When a power of attorney is given for some special act, it expires automatically as soon as that act is performed. When, however, it is desired to terminate the powers prior thereto, or where the power is a continuing one, a formal revocation is necessary. Notice of this revocation should be sent to the parties directly interested, and, in case of a general power of attorney, should also be published. Form 241. Revocation of Power of Attorney KNOW ALL MEN BY THESE PRESENTS : That the Berwell Investment Company, a corporation duly organized and existing under and by virtue of the laws of the State of New York, and having its 1610 CORPORATE FORMS Bk. IV- office and principal place of business at No. 30 Broad Street in the City of New York, has for good cause and consideration revoked, recalled, annulled, and made void, and by these presents does revoke, recall, annul, and make void a certain power of attorney given under the corporate signature and seal on the i8th day of January, 1922, to Horace M. Maxwell of Houston, Texas, and authorizing and empowering him to handle for and in behalf of this Company the cast half of the league of land in Brazos County, Texas, known as the J. J. Oliver League, and the said Berwell Investment Company does hereby withdraw, deny, and cancel any and all powers and authorities whatsoever therein expressed and conveyed. IN WITNESS WHEREOF, the said Berwell Investment Company has caused its corporate signature and seal to be hereunto affixed by its President and Secretary in the City of New York on this 2gth day of March, 1922. / CORPORATE 1 BERWELL INVESTMENT COMPANY, \ SEAL J By JAMES WARREN, President WILLIS BAKER, Secretary CORPORATE CONTRACTS AND ASSIGNMENTS / Corporate contracts differ in nowise from contracts between individuals, save in the verbiage necessary to adapt them to the corporate form. The forms which follow are included to illus- trate this adaptation. Form 242. Corporate Contract CONTRACT AN AGREEMENT, made and entered into this 25th day of June, A. D. 192.-!, by and between the Atlas Lithographing Company, a corporation duly organized under the laws of the State of Maine and having its usual place of business in Boston, Massachusetts, party of the first part, and the Selby Lithographing Com- pany, a corporation organized under the laws of the State of New York, and having its principal office and place of business at No. 265 Center Street, in the City of New York, party of the second part. For and in consideration of the sum of One Dollar and of other valuable con- siderations passing between the parties hereto, the receipt whereof is hereby respectively acknowledged, it is agreed as follows: i. That the said party of the first part shall employ one John H. Bernard of Boston, Massachusetts, for account of both the parties hereunto, to work upon and perfect as far as may be, a certain improvement in lithography known as the "Silver Plate Process," said process being now the joint property of the said parties to this present agreement. Ch. 22] CORPORATE CONTRACTS AND ASSIGNMENTS 1611 2. That said party of the first part shall pay the said John H. Bernard a salary not exceeding Three Hundred Dollars ($300) a month, and shall also furnish such materials, supplies, and assistance as the said John H. Bernard may reasonably require in the progress of his work. 3. That at the end of each quarter said party of the first part shall render a statement of the expenses incurred by reason of the employment of the said John H. Bernard for the perfection of the said Silver Plate Process, and said party of the second part shall within ten days of the receipt of said statement remit one-half thereof to the said party of the first part. 4. That all improvements in said Silver Plate Process or in connection there- with that may be made or discovered by the said John H. Bernard, shall be the joint and equal property of the two parties to this present agreement, and patents therefor shall be taken out in the names of the said parties of this present agreement and at their joint expense. 5. That said employment of said John H. Bernard shall continue for one year from date, unless sooner terminated by mutual agreement or by circumstances beyond the control of the parties hereto. IN WITNESS WHEREOF, the said parties of the first and second parts have caused their respective corporate signatures and seals to be hereunto affixed by their duly authorized officers, all being done in the City, County, and State of New York on the day and year first above written. ATLAS LITHOGRAPHING COMPANY, CORPORATE \ By HOWARD BREVOORT, President Attest seal: WILLIS JOHNSON, Secretary SELBY LITHOGRAPHING COMPANY, CORPORATE \ By JOHN H. ASWELL, SEAL } V ice-President Attest seal: FRANK H. PARSONS, Secretary This agreement might or might not be acknowledged, at the discretion of the parties. The contract as executed is legally sufficient. The only advantage to be'gained by an acknowledg- ment is the greater ease of proving the authenticity and due execution of the instrument in case of litigation. Form 243. Corporate Bill of Sale BILL OF SALE KNOW ALL MEN BY THESE PRESENTS: That the Standard Laundry Machine Company, a corporation duly organized under the laws of the State of New York, with its principal office and place of 1612 CORPORATE FORMS [Bk. IV- L business at No. 50 Dey St., in the City of New York, in consideration of the sum o One Thousand Dollars ($1,000) to it paid by the Barton Laundry Company of No. 71 East 2ist Street, New York City, the receipt whereof is hereby acknowl- edged, does hereby sell, transfer, and assign to the said Barton Laundry Company the following goods and chattels, viz. : All of the laundry machinery, tools, and apparatus of every kind now in the premises at No. 365 West igth St., formerly occupied by the Union Laundry Company, all as set forth and specified in the annexed schedule; to have and to holy all and singular the said goods and chattels to the said Barton Laundry Compand, its successors and assigns to their own use and behoof forever, and the said Standard Laundry Machine Company does hereby covenant with the said grantee that the said Standard Laundry Machine Company is the lawful owner of said goods and chattels; that they are free from all liens; that it has good right to sell the same as aforesaid; and that it will warrant and defend the same against the lawful claims and demands of all persons. IN WITNESS WHEREOF, the said Standard Laundry Machine Company has caused its corporate name to be signed hereunto by its President, and its corporate seal to be affixed and duly attested by its Secretary, said corporate seal being affixed both to these presents and to the schedule hereunto annexed, all being done in the City of New York, on this loth day of May, 1922. (Signature and attested seal.) The inventory or schedule of the goods conveyed by this bill of sale should be attached to it, and, in accordance with the provisions of the conveyance, be identified by the duly attested seal of the company. Form 244. Assignment of Contract ASSIGNMENT KNOW ALL MEN BY THESE PRESENTS: That for and in consideration of the payment by the Connecticut Valley Paper Mills, a corporation organized under the laws of the State of Connecticut and having its principal office and place of business at 525 Main Street, New Haven, Connec- ticut, of Twenty-five Thousand, Seven Hundred and Forty-Five Dollars ($25,745) to the Holden Chemical Company, a corporation duly organized under the laws of the State of New York, and having its principal office and place of business at 152 Warren Street, New York City, the receipt of which payment is by the last-named corporation hereby acknowledged, said Holden Chemical Company does hereby assign, transfer, and convey to the said Connecticut Valley Paper Mills, all and singular, its right, title, and interest of every kind in and to a certain contract (copy of which is hereunto annexed and made part of this present instrument) entered into on the 3ist day of July, 1921, between Martin S. Coleman of Brooklyn, New York, and the said Holden Chemical Company, said contract vesting in the said kst-named company, its successors and assigns, under the conditions set forth in said contract, the exclusive right to acquire and use all the inventions and processes Ch. 22} CORPORATE CONTRACTS AND ASSIGNMENTS 1613 that may hereafter be made, discovered, or devised by the said Coleman for the manufacture of paper or to be used in connection therewith, said contract being conveyed to and accepted by the said Connecticut Valley Paper Mills with all its rights, privileges, and obligations as herein set forth and as hereunto held by the said Holden Chemical Company. IN WITNESS WHEREOF, the said Holden Chemical Company has hereunto caused its corporate name and seal to be affixed by its President and Secretary, all being done in the City, County, and State of New York, on this 28th day of January, 1922. ( CORPORATE \ HOLDEN CHEMICAL COMPANY, I SEAL / By JAMES HOLDEN, President HAROLD SHELDON, Secretary Acknowledgment is not essential to this assignment but is advisable. The instrument as given does not relieve the assign- ing company from liability under the assigned contract. To secure this, a specific release from the other party to the assigned contract is essential. A simple form of such release to follow, or be attached to, the assignment is as follows: Form 245. Assent to Assignment of Contract I, Martin S. Coleman of Brooklyn, New York, party of the first part to a certain contract entered into on the 3ist day of July, 1921, with the Holden Chemical Company of New York City, do for good and valuable considerations, the receipt of which is hereby acknowledged, consent and agree to the transfer of said contract to the Connecticut Valley Paper Mills as set forth in the foregoing assign- ment, and to the substitution of the said Connecticut Valley Paper Mills for the Holden Chemical Company in said contract, and do hereby release, relieve, and discharge the said Holden Chemical Company from any claim, liability, or other obligation for, on account of, or by reason of said contract. Witness my hand and seal this 28th day of January, 1922. MARTIN S. COLEMAN [L. s ] The assignment of contract which follows is informal but sufficient where the whole transaction is well understood. In practice it is usually indorsed on the back of the contract to be assigned, or, with the word "within" changed to "above and foregoing," is placed on the last page of the contract. 1614 CORPORATE FORMS [Bk. IV- Form 246. Assignment of Contract By Indorsement For and in consideration of One Dollar and of other sufficient considerations, the receipt of all which is hereby acknowledged, the Sterling Power Company does hereby sell, assign, and transfer to the Cohoes Light and Power Company the within contract with all the rights, privileges, obligations, and undertakings thereof as therein set forth. IN WITNESS WHEREOF, the signature and the attested seal of the said Sterling Power Company are hereunto affixed by its duly authorized officers this i6th day of May, 1922. / CORPORATE \ STERLING POWER COMPANY, \ SEAL / By MILLER STERLING, President Attest seal: HENRY WELLING, Secretary The patent assignment which follows is in general accord with the forms approved by the Patent Office. Form 247. Assignment of Patent Individual to Corporation ASSIGNMENT OF PATENT WHEREAS, I, Alan Hudson, of Newburgh, County of Orange, State of New York, did obtain letters patent of the United States for an improvement in Car Couplings, which letters patent are numbered 605,948, and bear date the 6th day of November in the year 1921; and WHEREAS, I am now the sole owner of said patent, and of all rights under the same; and WHEREAS, The Montauk Car Coupler Company, a corporation duly organized under the laws of the State of New Jersey, and having its principal office and place of business at No. 15 Exchange Place, Jersey City, New Jersey, is desirous of acquiring the entire interest in the same together with all claims for profits and damages arising from past infringements thereof, and the right to sue for and recover in its own name on all claims for such infringements: Now, THEREFORE, To all whom it may concern, be it known, that for and in consideration of the issue to my order by the said Montauk Car Coupler Company of its entire capital stock, excepting Ten (10) Shares heretofore issued to the incorporators of said Company, the receipt of which aforesaid stock, of the face value of Ninety-nine Thousand Dollars ($99,000), is hereby acknowledged, I, the said Alan Hudson, have sold, assigned, and transferred, and by these presents do sell, assign, and transfer, unto the said Montauk Car Coupler Company, the whole right, title, and interest for the United States, its colonies, and dependencies, in and to the said improvement in car couplings, and in and to the letters patent therefor aforesaid; and to the inventions covered thereby, together with all claims for profits and damages arising from past infringements of the said letters patent, and the right to sue and recover, in its own name, on all claims for such infringe- ments; said letters patent and all the connected rights as herein set forth to be held Ch. 22] CORPORATE CONTRACTS AND ASSIGNMENTS 1615 and enjoyed by the said Montauk Car Coupling Company for its own use and behoof, and for the uses and behoof of its legal representatives, successors, and assigns, to the end of the term for which said letters patent are or may be granted, as fully and entirely as the same would have been held and enjoyed by me had this assignment and sale not been made. IN TESTIMONY WHEREOF, I have hereunto set my hand and affixed my seal at Newburgh, County of Orange, State of New York, this 4th day of May, 1922. ALAN HUDSON fi.. s.J In presence of: JACOB ELLIS HENDRICK N. ENSLOW An assignment of patent does not, under the rules of the Patent Office, require notarial acknowledgment, but as an acknowledgment, as already stated, is prima facie evidence of the due execution of the instrument, it is usually affixed. CHAPTER XXIII BONDS OF INDEMNITY The treasurer's bond is the formal undertaking of parties named therein and by whom the bond is signed, that in event of loss arising from specified acts, failures, or omissions on the part of the treasurer, they will make good the loss up to the amount of the bond. Formerly bonds of this nature were almost invariably signed by the treasurer and his friends. Of recent years, however, surety company bonds have largely superseded these personal bonds. The following is a common form of treasurer's personal bond. Form 248. Treasurer's Bond Personal TREASURER'S BOND KNOW ALL MEN BY THESE PRESENTS: That we, Robert A. Bruce of New York City, as principal, and William H. Cain of Newark, New Jersey, and H. B. McMillan of Brooklyn, New York, as sureties, are held and firmly bound unto the Sterling Transportation Company, a corporation duly organized under the laws of the State of New York, in the sum of Ten Thousand Dollars ($10,000), to the payment of which to the said corpora- tion, its successors, or assigns, we do by these presents jointly and severally bind ourselves, our heirs, executors, and administrators. Signed and sealed this isth day of March, 1922. The condition of the above obligation is that: WHEREAS, The said Robert A. Bruce has been elected Treasurer of the said Sterling Transportation Company for the period of one year from the loth day of March, 1922, and may hereafter be re-elected to or continue in such office for a further period : Now, THEREFORE, If the said Robert A. Bruce shall hereafter in all respects fully, faithfully, and honestly perform and discharge the duties of said office so long as he shall continue therein, both during the term for which he has been elected and during such further time as he may continue therein, whether by re-election or otherwise, and shall when properly so required, fully and faithfully account to the said corporation, its successors, or assigns, for all moneys, goods, and prop- erties whatsoever, for or with which the said Robert A. Bruce may in anywise be accountable or beholden to the said corporation, and if at the expiration of his 1616 Ch. 23] BONDS OF INDEMNITY 1617 term of office, or prior thereto in the event of his death, resignation, or removal from office, all books, papers, vouchers, money, and other property of whatever kind placed in his custody as Treasurer of said corporation, shall be forthwith restored to the said corporation, its successors, or assigns, then this obligation shall be void, but otherwise to remain in full force and effect. ROBERT A. BRUCE [L. s.] WILLIAM H. CAIN [L. s.] H. B. MCMILLAN [L. s.] Signed, sealed and delivered in the presence of: JOHN J. BARR W. H. CARPENTER The treasurer's bond must be given under seal, and, while not legally necessary, personal bonds are usually acknowledged. Personal bonds are, as a rule, sweeping in their nature, cover- ing any and all losses arising through any errors, misdeeds, or omissions of the treasurer. When, however, a surety company enters the bonding field, the guaranties are reduced to the lowest possible terms usually to losses arising through the personal dishonesty of the employee amounting to "larceny or embezzle- ment." The forms for these bonds are furnished by the surety companies and vary according to the company and the condi- tions. The general form employed is too lengthy for reproduc- tion in the present volume. When a stock certificate is lost or destroyed, a bond of in- demnity is usually required before the corporate authorities will undertake to replace the lost stock certificate. 1 Form 249. Indemnity Bond for Lost Stock Certificate INDEMNITY BOND KNOW ALL MEN BY THESE PRESENTS: That we, John R. McAllister of Yonkers, New York, as principal, and Charles Foster and Henry H. Clark, both also of Yonkers, New York, as sureties, are held and firmly bound unto the Sterling Transportation Company, a corporation duly organized under the laws of the State of New York, in the sum of Five Thousand 1 See Book I, f 265, for discussion of lost stock certificates. 1618 CORPORATE FORMS [Bk. IV- Dollars ($5,00x3), to the payment of which to the said corporation, its successors or assigns, we do by these presents jointly and severally bind ourselves, our heirs, executors and administrators. Signed and sealed this i8th day of May, 1922. The condition of the foregoing obligation is that: WHEREAS, The said John R. McAllister is the owner of record, as shown by the stock book of the corporation, of Forty (40) Shares of the Common Capital Stock of the said Sterling Transportation Company, each of the par value of One Hundred Dollars ($100), the ownership of said stock being further evidenced by Certificate No. 375 issued in the name of the said John R. McAllister on the isth day of August, 1921; and WHEREAS, The said John R. McAllister has made application to the Board of Directors of the Sterling Transportation Company for the issue in his name of a new certificate for the said Forty (40) Shares of stock of the said Company, alleging that original Certificate No. 375 is lost, stolen, or destroyed and that its present whereabouts and condition are unknown to him; and WHEREAS, By due and formal resolution of the said Board of Directors, said application has been granted and a new certificate for said Forty (40) Shares of the stock of the said Sterling Transportation Company has this day been issued to the said John R. McAllister: Now, THEREFORE, If the said John R. McAllister, his heirs, executors, and administrators, or any of them, do and shall at all times hereafter, save, defend, and indemnify the said Sterling Transportation Company, its legal successors or assigns, of, from and against all demands, claims, or causes of action arising from or on account of the loss of said Certificate No. 375 for Forty (40) Shares of the Com- mon Capital Stock of said Company and the issue of said new certificate in place thereof, and of, and from, all costs, damages, and expenses that shall or may arise because of said reissue, and shall also deliver or cause to be delivered up to the said Sterling Transportation Company for cancellation the said missing Certificate No. 375 whenever and so soon as the same shall be found or recovered, or corre into his possession, then this obligation shall be void; otherwise to remain in full force and effect. JOHN R. MCALLISTER [L. s.] CHARLES FOSTER [L. s.j HENRY H. CLARK [L. s.j Signed, sealed and delivered in the presence of: DANIEL T. BAIRD JOHN K. STONE Part IV Forms Relating to Bond Issues CHAPTER XXIV BOND ISSUES THE BOND The formalities of a bond issue are usually regulated by the statutes of the particular state in which the corporation is organ- ized. Thus in New York an issue of bonds requires (i) a stock- holders' resolution or written consent; (2) a certificate of the corporate officials that the stockholders' consent has been given ; and (3) a directors' resolution reciting the facts, authorizing the officers to proceed in the matter, and providing for the details of the transaction. The matter is one to be undertaken only by a skilled lawyer. In some states the mere resolution of the board of directors is sufficient to authorize a bond issue. In a large number of states the assent of a prescribed majority of the stockholders is a requisite. As a matter of prudence and good business, a proper stockholders' authorization is always desirable regardless of the statutory requirements existing in the particular state. The more important instruments involved in an issue of corporate bonds are the bond itself, which ie comparatively simple in form, and the mortgage or deed of trust, which is lengthy and complex. The corporate bond in its usual form is a promissory note, differing from the ordinary corporate note only in its formality, its more complete statement of the conditions under which it is issued, its formal execution, and in its being one of a series of like obligations equally secured by the same collateral or, if unsecured, of the same rank. 1619 l620 CORPORATE FORMS [Bk. IV- There is practically no difference as to form between a bond and the short-term note so frequently issued by corporations of the present day, save as to the length of time for which the obliga- tion runs. The short-term note, as its name indicates, is usually given for a short period one to five years while the bond usually extends over a much longer period, ranging from five to one hundred years or more. Interest on bonds is usually represented and provided for by means of coupons, which are in effect also promissory notes, payable to bearer, each calling for the payment of one instal- ment of interest on the bonds. This interest when due is pay- able only on surrender of the proper coupon and, in the absence of some good reason otherwise, such as notice that the particular coupon has been stolen, is payable to anyone who presents the coupon. Interest on bonds is usually payable semiannually and each of the coupons of a coupon bond calls for the exact amount of one of the semiannual interest payments on that bond. Thus, a bond running ten years with interest payable semiannually, will have attached to it twenty coupons. Each coupon bears the same number as its bond for purposes of general identifica- tion, but also has a serial number and date or some other specific statement indicating the order in which it comes due and the particular interest payment for which it calls. Coupon bonds are usually made payable to bearer, and owner- ship passes by delivery. When it is desired that bonds shall not pass by mere delivery, they are registered, i.e., issued in the name of some particular person as is a certificate of stock, the bond thereafter transferable only on the books of the company. Coupon bonds are sometimes registered as to principal, but the coupons are still made payable to bearer. The interest then is paid to anyone who presents the coupon, but the principal when due is paid only to the person in whose name the bond stands on the books of the company. Bonds without coupons are always registered, and are trans- Ch. 24] BOND ISSUES THE BOND 1621 f erred only by assignment; interest is payable to the registered owner alone, and is usually paid by check sent out to these registered owners. Coupon bonds payable to bearer and registered bonds with- out coupons are often issued under the same deed of trust. Usually when this is done, the two classes of bonds are made interchangeable,i.e., the holder of a coupon bondmay atanytime exchange it for a registered bond, or vice versa. The advantage of the unregistered coupon bond is found in the readiness with which it may be transferred. The advantage of a registered bond lies in the difficulty of its negotiation in case the bond is lost or stolen. The bond register is a book of record in which are entered the data relating to bond issues, showing for each bond, its number, date, names of the parties to whom issued, any transfers, and the due dates and amounts of interest payments. The coupon register is, as its name indicates, a book in which coupons, clipped and presented for payment, are, after cancellation, pasted in convenient form for subsequent reference. The following form is that of a coupon bond, the ownership passing by mere delivery. It may, however, be registered at the option of the owner, though this registration does not affect the coupons. These pass by delivery alone and are payable to bearer regardless of whether the bond be registered or transfer- able by delivery. . Form 250. Coupon Bond UNITED STATES OF AMERICA STATE OF NEW YORK No. 375 . $500.00 MAXWELL COMPRESSOR COMPANY First Mortgage Seven Per Cent Gold Bonds KNOW ALL MEN BY THESE PRESENTS, That the Maxwell Compressor Com- pany, a corporation organized under the laws of the State of New York, for value received, hereby promises to pay to the bearer hereof, or if this bond is registered, 1622 CORPORATE FORMS [Bk. IV- to the registered holder thereof, at the office of the Securities Trust Company of the City of New York, on the first day of December, nineteen hundred and fifty-one, in gold coin of the United States of America, of the present standard of weight and fineness, or its equivalent, the sum of Five Hundred Dollars, without deduction from either such principal or interest for or on account of any United States, State, municipal, or other tax or taxes which the Maxwell Compressor Company, its successors or assigns, may be required to pay or deduct therefrom, and the Maxwell Compressor Company hereby covenants and agrees to pay all such tax or taxes, and in the meantime to pay interest upon the said sum of Five Hundred Dollars from and after the first day of December, nineteen hundred and twenty-one, at the rate of Seven Per Cent per annum, payable in like gold coin, or its equivalent, at the same place, semiannually, on the first days of June and December in each year, beginning with the first day of June, 1922, on presentation and surrender, of the coupons hereto attached as each of them becomes due. This bond is one of a series of One Thousand (1,000) bonds of the same tenor and date, aggregating Five Hundred Thousand Dollars ($500,000), numbered consecutively from one to one thousand, both inclusive, for the sum of Five Hun- dred Dollars ($500) each, all of which bonds are secured equally by a deed of trust, which is a first mortgage upon the properties of the Maxwell Compressor Com- pany, executed and delivered by the said Maxwell Compressor Company to the said Securities Trust Company, as Trustee, granting and conveying in trust and mortgaging as security for the payment of the principal of said bonds at maturity, at par, and the interest on said bonds, payable semiannually at the rate aforesaid, all the real estate and other property of the said Maxwell Compressor Company mentioned and described in said deed of trust, with full power to use and sell the same in the event of default in payment of the bonds or coupons, or any of them, and apply the proceeds to the payment of same as in said deed of trust provided. This bond is issued, received, and held subject to all and singular the terms and condi- tions contained in the deed of trust aforesaid. This bond is further secured by a sinking fund, which shall consist of and be maintained by the payment to the said Securities Trust Company by the Maxwell Compressor Company on the first day of December, 1926, and on each succeeding first day of December thereafter, until the redemption of all the bonds issued under said deed of trust, of Twenty-Five Dollars for each Thousand Dollars of bonds then issued and outstanding, such moneys so paid to be used in the purchase of outstanding bonds at the lowest price at which they may be had, not exceeding, however, One Hundred and Ten Per Centum of the face of said bonds plus accrued interest, and if bonds cannot be so purchased, such moneys shall be used in the redemption of the bonds outstanding, as hereinafter provided. This bond shall not become obligatory until the certificate indorsed hereon shall be signed by the Trustee, and when so authenticated by the signature of the trustee, the title to said bond shall pass by delivery, unless said bond is registered, and, if registered, the title thereto shall pass only by transfer on the books of said Trust Company, and no transfer except upon said books shall be valid unless the last transfer shall have been to bearer, which shall restore transferability by delivery. This bond is redeemable, at the option of the Maxwell Compressor Company, on any interest day at any time after the first day of December, 1926, at One Hun- dred and Ten Per Cent of its face value, plus accrued interest, provided that thirty days' notice of such redemption shall be given the holder thereof by notice pub- lished once a week for four consecutive weeks prior to such redemption, in a news- paper published in New York City. IN WITNESS WHEREOF, the said Maxwell Compressoi Company hath caused these presents to be signed by its President, and its corporate seal, duly attested by its Secretary, to be hereunto affixed, and hath hereunto affixed coupons with the name of its Treasurer engraved Ch. 24] BOND ISSUES THE BOND 1623 thereon, and hath caused this bond to be dated the first day of December, A. D., one thousand, nine hundred and twenty-one. /CORPORATE \ MAXWELL COMPRESSOR COMPANY, \ SEAL / By HOWARD M. MAXWELL, President Attest: FRANK PAULSON, Secretary The coupon form which follows is as it appears attached to the preceding bond. Form 250 a. Coupon No. I $17.50 MAXWELL COMPRESSOR COMPANY will pay to the bearer at the office of the Securities Trust Company of the City of New York the sum of Seventeen Dollars and Fifty Cents ($17.50), in United States Gold Coin, or its equivalent, on the first day of June, 1922, being six months' interest on its First Mortgage Seven Per Cent Gold Bond No. 375. WILLIAM H. POWERS, Treasurer The following trustee's certificate is as it appears upon the bond shown in Form 250. Form 251. Trustee's Certificate The Securities Trust Company of the City of New York hereby certifies that the within Bond is one of the series of Bonds described in the Deed of Trust therein mentioned. SECURITIES TRUST COMPANY OF THE CITY or NEW YORK, New York City, Trustee January 5, 1922 BY MALCOLM MCDONALD, President The debenture bond, as stated elsewhere, 1 is merely an unse- cured promise of a corporation to pay. The following is a very simple form of such bond. The bond calls for payment in gold and is also redeemable on any interest date before maturity at the option of the company. 1 See { 512; also Book II, |{ 92-94. 1624 CORPORATE FORMS [Bk. IV- Form 252. Debenture Bond Number 20 $500 EN GEL CHEMICAL CORPORATION EIGHT PER CENT GOLD BOND The Engel Chemical Corporation, a corporation duly incorporated and existing under and by virtue of the laws of the State of New York, doing business in the City of New York, doth hereby promise and agree to pay to the bearer the sum of Five Hundred Dollars ($500) in gold coin of the United States of America of the present standard of weight and fineness, at the office of the Company on the sixth day of October, 1924, with interest thereon from the sixth day of October, 1921, at the rate of eight per cent (8%) per annum, without any deduction from principal or interest for any tax or taxes which the Company may be required to pay or to retain therefrom by reason of any present or future laws of the United States or of the State of New York, as well as the normal income tax which the Company may be required to pay under any present or future law of the United States or the State of New York, the said Company hereby promising and agreeing to assume and to pay all such taxes. This bond is one of a series of twenty bonds each in the sum of Five Hundred Dollars numbered from (i) to (20) both inclusive and (200) bonds each in the sum of $100 numbered from (21) to (221) both inclusive and all of like date, tenor and effect, and is subject and subordinate to payment of the Company's business creditors and is issued subject to the conditions set forth in a resolution of the Board of Directors of the Company, authorizing the issuance hereof. This bond is redeemable on the sixth day of October in any year before matur- ity at the option of the said Company at par for each $100 of the face value of each bond, and all the accrued interest thereon in accordance with the conditions mentioned in said resolution. This bond shall pass by delivery or by transfer on the books of the Company. IN WITNESS WHEREOF, said Engel Chemical Corporation has caused these presents to be signed by its President, and sealed with its common or corporate seal duly attested by its Secretary pursuant to a resolution of its duly authorized Board of Directors, this sixth day of October, 1921. ENGEL CHEMICAL CORPORATION, / CORPORATE! By HENRY W. ENGEL, \ SEAL / President Attest: FRANK W. HENDERSON, Secretary CHAPTER XXV BOND ISSUES THE DEED OF TRUST The following deed of trust, while drawn in compliance with the requirements of the New York statutes, may be readily adapted for use in any other state. Form 253. Deed of Trust DEED OF TRUST THIS INDENTURE, made and entered into this 12th day of November, one thousand nine hundred and twenty-one, by and between the Maxwell Compressor Company, a corporation duly organized and existing under the laws of the State of New York, having its office at No. 170 Broadway, New York City, hereinafter called the Compressor Company, party of the first part, and the Securities Trust Company of the City of New York, a corporation duly organized and existing under the laws of the State of New York, having its principal office at No. 98 Wall Street, New York City, as Trustee, hereinafter called the Trusiee, party of second part; Witnessed! : WHEREAS, The Board of Directors of the said Compressor Company has, by the authority and with the consent of the stockholders thereof legally given, duly resolved to borrow Five Hundred Thousand Dollars ($500,000) for the lawful business purposes of the said Company, and for that purpose to execute and issue its First Mortgage Seven Per Cent Thirty- Year Gold Bonds of the par value of Five Hundred Dollars ($500) each, dated the first day of December, 1921, and payable on the first day of December, 1951, in gold coin of the United States of, or equivalent to, the present standard of weight and fineness, said bonds to bear interest at the rate of Seven Per Cent per annum, payable in like gold coin, sen.i- annually, on the first days of June and December in each year, from the first day of December, 1921, until the payment of the principal amount thereof; the payment of the principal and interest of said bonds to be secured by a mortgage or deed of trust that shall be a first mortgage on the entire property of the said Compressor Com- pany as hereinafter described, said deed of trust to be in substantially the form of this indenture; and WHEREAS, The bonds so to be issued are to be in substantially the form follow- ing, viz.: (See Form 250.) AND WHEREAS, There are to be attached to each of the said bonds, at the time of the issue thereof, coupons representing the semiannual instalments of interest which are to become due thereon, each of which coupons is to be substantially of the following tenor, the proper coupon number, date of payment, amount of the 1625 1626 CORPORATE FORMS [Bk. IV- bond and its number, and the engraved facsimile signature of the Treasurer of the Compressor Company, having been inserted in the respective blanks therefor, to wit: (See Form 251.) AND WHEREAS, On each of said bonds there is to be indorsed a certificate of the Trustee or its successor appointed hereunder, of the following tenor: (See Form 252-) Now, THEREFORE, The said Compressor Company, in consideration of the premises and of the sum of one dollar to it in hand paid by the said Trustee, the receipt whereof is hereby acknowledged, and in order to secure the due payment of the principal and interest of the bonds to be issued hereunder, and to insure the faithful performance of the covenants and agreements herein contained, hath granted, bargained, sold, aliened, assigned, conveyed, transferred, and set over, and by these presents doth grant, bargain, sell, alien, assign, convey, transfer, and set over unto the said Trustee, its successors and assigns; All of the following described property and franchises of the Company, to wit : (Specific description of the property mortgaged.) To HAVE AND TO HOLD all and singular the said property, with all real estate, buildings, fixtures, articles, and property of every kind, belonging to or pertaining to the same, unto the said Trustee, its successors and assigns forever; IN TRUST NEVERTHELESS, for the equal pro rata benefit and security of any and all persons and parties who may be or become the owners or lawful holders of any of the bonds to be issued hereunder and secured hereby, irrespective of date or priority of issue, without any discrimination, preference, or priority of any one bond over another or others, by reason of priority in time of issue, or sale, or negotiation thereof, or otherwise, and to secure the due payment of each of the said bonds together with the interest thereon, and for the uses and purposes and upon the terms and conditions hereinafter declared and expressed; and IT Is HEREBY EXPRESSLY COVENANTED AND AGREED by and between the parties hereto, that all such bonds are to be issued, negotiated, and received, and that the said property and franchises mortgaged are to be held by the Trustee upon and subject to the following further trusts, uses, conditions, and covenants, that is to say: First The bonds to be issued hereunder shall be executed on behalf of the Compressor Company by its proper officers and shall be delivered to the Trustee for certification, and said Trustee shall certify and deliver said bonds so certified upon the order of the Board of Directors of the Compressor Company. An order in due form, purporting to be such order for delivery of said bonds and believed by the Trustee to be genuine, shall be conclusive authority and full protection to the Trustee for the certification and delivery of said bonds. Only such bonds as shall bear thereon indorsed the Trustee's certificate, duly executed, shall be secured by this indenture, or entitled to any lien, right, or benefit thereunder, and such certificate of the Trustee upon any such bond executed by the Compressor Company shall be conclusive evidence that the bond so certified has been duly issued thereunder, and that the holder is entitled to the benefit of the trust hereby created. Before certifying or delivering any bond, all coupons thereon then matured shall be cut off, canceled, and delivered to the Compressor Company. Second All bonds secured hereunder may be registered in the name of the holder, when so requested by such holder, upon bond transfer books which the Compressor Company shall maintain and keep for such purpose at the office of the Trustee in the City of New York as long as any of the said bonds shall remain out- Ch. 25] BOND ISSUES THE DEED OF TRUST 1627 standing. After such registration such bonds shall be transferable only upon such transfer books, by the registered owner or his lawful attorney, and any such transfer shall be noted on the bonds by the indorsement of the Transfer Agent hereinafter appointed. After registration of any bond, the principal thereof shall be payable only to the registered owner, but the coupons shall be payable to the bearer upon presentation and surrender thereof, and shall be negotiable by delivery as if such bond was not registered. Any registered bond may at any time be transferred by the registered owner thereof, upon said transfer books to bearer, and such transfer shall be noted upon said bond, and the said bond shall thereupon be negotiable by delivery as if it had never been registered, and each of said bonds shall continue subject to successive Registrations and transfers to bearer at the option of the holder thereof. For the purpose of registering and transferring said bonds as above set forth, the Securities Trust Company of the City of New York is hereby appointed and constituted Transfer Agent of the said Compressor Company. Third Until default shall be made by the Compressor Company, its successors or assigns, in the payment of the principal or interest of the bonds hereby secured, or any of them, or in the performance of any of the covenants, agreements, and provisions on its part to be kept and performed, as herein set forth, the Compressor Company, its successors and assigns, shall be permitted to possess, manage, use, and occupy the premises affected hereby, with all their appurtenances and belongings in all respects as fully as if this indenture had not been made. Fourth If the Compressor Company shall well and truly pay to the holders thereof the principal of the bonds secured hereunder and the interest moneys becoming due thereon respectively at the time and in the manner specified in the said bonds and coupons thereto annexed, and shall keep and perform all the covenants, agreements, and stipulations on its part in said bonds or in this agree- ment contained, then these presents and the trust hereby created shall cease and determine, and the said Trustee shall in such event release and discharge this mortgage and the property and premises encumbered thereby The Trustee may also execute such release and discharge upon production by the Compressor Com- pany or its assigns of all the bonds issued hereunder, together with the coupons thereto belonging, canceled or for cancellation, and the Trustee shall not be under any liability or obligation to inquire into the holding of said bonds by the Com- pressor Company or its successors or assigns. Fifth The said Compressor Company, while it shall be in possession of the mortgaged premises, and while there shall be no existing default in respect of the payment of the principal or interest of any of the said bonds of the Compressor Company, or in the performance of any of the covenants herein, may, with the consent in writing of the Trustee, sell any portion of the premises heretofore granted. If, in the opinion of the Board of Directors of the Compressor Company, such sale or change shall be expedient, said opinion shall be expressed in a resolution of the said Board, and the Trustee may upon delivery to it of a copy of the resolution of the Board of Directors to that effect release from the lien and operation of this indenture any part of the premises hereby mortgaged, provided that the purchase money from such sale or sales shall be paid to the said Trustee for application to the discharge of the bonds and coupons hereunder issued, as set forth in Section Fif- teenth, or to be set aside to be applied by the Compressor Company in payment for other real or personal property, or in betterments of, or additions to, somepart of the premises mortgaged hereby, and until so applied shall be held by the Trustee. Any new property so acquired by the Compressor Company shall ipso facto . become and be subject to the lien of this indenture as fully as if specifically mortgaged or pledged hereby, but if requested by the Trustee the Compressor Company shall execute special instruments of incumbrance upon such properties. 1628 CORPORATE FORMS [Bk. IV Sixth The Compressor Company covenants and agrees that it shall and will promptly pay the interest and the principal of the bonds hereby secured, at the time and in the manner specified in said bonds and the coupons thereto attached, without deduction from either such principal or interest for or on account of any United States, State, municipal, or other tax or taxes which the Compressor Company, its successors or assigns, may be required to pay or deduct therefrom, and the Compressor Company hereby covenants and agrees to pay all such tax or taxes. The Compressor Company further covenants and agrees that it shall and will, from time to time, promptly pay and discharge, or cause to be paid and discharged, all taxes, rates, levies, or assessments and charges, ordinary and extraordinary, levied or imposed upon the premises and properties mortgaged to the Trustee to secure the payment of the bonds issued hereunder, whereby the lien of this inden- ture might or could be impaired, until the bonds so secured hereunder, with all the interest accrued thereon, shall have been fully paid and satisfied. The Compressor Company further covenants and agrees that it will not create nor suffer any mechanic's, laborer's, or other similar liens to be created upon the premises and property mortgaged to secure the bonds issued hereunder, whereby a lien might be created that might or could be held prior or equal to the lien of this indenture, so that the same shall not fall into arrears and so that the priority of this indenture given to secure said bonds shall be preserved. Seventh A sinking fund shall be created for the redemption of the bonds issued hereunder. It shall consist of and be maintained by the payment to the Trustee by the Compressor Company on the first day of December, 1926, and on each succeeding first day of December, thereafter until the redemption of all the bonds issued hereunder, of Twenty-five Dollars ($25) for each Thousand Dollars of bonds then issued and outstanding, such moneys so paid to be used in the purchase of outstanding bonds at the lowest price at which they may be had, not exceeding, however, One Hundred and Ten Per Centum (110%) of the face value of said bonds, plus accrued interest, and if bonds cannot be so purchased, such money shall be used in redemption of bonds outstanding as provided and set forth in Section Fifteenth of this present indenture. Eighth The Compressor Company covenants and agrees that this deed of trust delivered to the Trustee shall be a first mortgage upon the premises and property affected' thereby, that the same shall be duly executed and recorded in the proper office of registry in the County of New York where the said premises are situated, and that the Compressor Company will execute and deliver such further deeds, transfers, pledges, and assurances as the Trustee, under the advice of counsel learned in the law, shall reasonably require for the better accomplishing of the purposes and provisions of this indenture. Ninth The Compressor Company covenants and agrees that all buildings, structures, and machinery situated upon the properties affected by this mortgage given to secure the bonds issued hereunder, shall be kept insured during the entire term of this indenture to the amount of insurance on such properties usually allowed by insurance companies, against loss or damage by fire, and against loss or damage from boiler explosions, and that the said Compressor Company shah 1 and will pay all premiums upon all policies for such insurance. All such policies shall be made payable to the Trustee, and shall be deposited with it for the benefit and protection of the bondholders should any loss occur from fire or from boiler explosion during the term of this indenture. Any payments of insurance made under such policies may be applied directly by the Trustee to the repairing or replacement of the property damaged or destroyed, or it may authorize the Compressor Company to contract for such repairs or replacements, and pay part or all of the cost thereof from said insurance moneys. The Trustee may in its discretion employ such Ch. 25] BOND ISSUES THE DEED OF TRUST 1629 / insurance moneys in the purchase or redemption of outstanding bonds as set forth in Section Fifteenth, instead of expending the same for repairs or replacement of property damaged or destroyed. Tenth The Compressor Company covenants and agrees that it shall and will at all times keep the buildings, structures, and appurtenances thereto, or any replacement or replacements thereof, in good order and repair, provided, however, that in the event of total destruction of any building, the Compressor Company may, with the consent of the Trustee, add to the insurance moneys received thereon by the Trustee sufficient cash payments to release the special property upon which such building was situated, under the terms set forth in Section Fifth, whereupon the Trustee shall release the said property and the Compressor Company may dispose of the same at its discretion. Eleventh The Compressor Company covenants and agrees that when and as the coupons attached to the bonds issued hereunder are paid, the coupons shall be canceled, and that no purchase or sale of the said coupons or advance or loan upon the same, made on behalf of, or at the request of, or with the privity of the said Compressor Company, and no redemption of the said coupons, or any of them, by any guarantor of the payment of the same, shall be taken, or operate, as keeping the said coupons alive or in force under this indenture as against the holders of the bonds secured hereunder and of the coupons annexed thereto. Twelfth In case default shall be made in the payment of interest on any of the bonds issued hereunder, and such default shall continue for a period of six months after demand, or in case default shall be made in the performance of any other covenant or condition hereby required to be kept or performed by the Compressor Company, and the same shall continue for a period of six months after demand made for such performance, the Trustee may, and, upon the written request of the majority in amount of the holders of the bonds then outstanding, shall by written notice to the Compressor Company, declare the principal of all the bonds hereby secured, then outstanding, to be due, and the same shall thereupon become im- mediately due and payable. Thirteenth In case default shall be made in the payments of the principal or interest of any of the said bonds when the same is due and payable according to the tenor thereof, or if default shall be made in the performance of any other covenant or condition, hereby required to be kept or performed by the Compressor Company, and any such default in payment or performance shall continue for a period of six months after demand by the Trustee, then and in every such case the Trustee, or its successors in the Trust, may by its attorneys and agents enter into and upon all and singular the premises hereby conveyed, and each and every part thereof, and operate and conduct the business of the said Compressor Company in all respects as the said Compressor Company might do in possession of the same; and may collect and receive all rents, income, revenue, and profit to be derived therefrom, and after deducting all proper and necessary outlays and expenses as well as a just compensation for its own services and for the services of such attorneys, agents, and assistants as it may, in its discretion, employ for any of the purposes aforesaid, said Trustee shall apply the rest and residue of the moneys received by it pro rata to the payment of the interest due upon such of said bonds as shall then be out- standing. In any such case if payment of all interest and any principal due shall be made in full and no suit to foreclose this mortgage shall have oeen begun or sale made, the said Trustee shall restore the possession of the premises so entered, to the Compressor Company without prejudice to similar entry later in case of similar default. Fourteenth In case default shall be made in the payment of the principal or interest of the said bonds, when the same is due and payable according to the tenor 1630 CORPORATE FORMS [Bk. IV- thereof, or if default shall be made in the performance of any other covenant or condition hereby required to be kept or performed by the Compressor Company, and any such default in payment or performance shall continue for the period of six months after demand, the Trustee may, and upon written request of the holders of a majority in amount of the registered bonds then outstanding, being first in- demnified by them to its satisfaction, shall sell or foreclose upon, according to the proceedings by law prescribed in this state, all or any portion of the property held by it under this indenture, and such proceedings of- sale or foreclosure shall be a perpetual bar both at law and in equity against the Compressor Company and against all persons claiming by, from, or under it. After deducting from the pro- ceeds of such sale or foreclosure, the proper allowance for all expenses thereof, including attorney's and counsel fees, and all other expenses or advances which may have been made or incurred by said Trustee in respect of the said property or the appurtenances hereto, and all payments which may have been made by it for taxes or assessments, or in satisfaction of charges and liens, prior to the lien of the mortgages and deeds of trust to the Trustee thereon, or for insurance, as well as reasonable compensation for its own services, the Trustee shall apply the proceeds to the payments of such bonds and the coupons thereon as may be at the time unpaid, without giving preference or priority to one bond over another, but ratably to the aggregate amount of such unpaid principal and accrued and unpaid interest, and if any surplus remain after the payment in full of the principal and interest of said bonds, then the Trustee shall transfer and pay over such surplus to the Compressor Company. Fifteenth It is covenanted and agreed between the parties hereto and any future holders of the bonds that the said bonds are redeemable, at the option of the party of the first part, on any interest day after the first day of December, 1922, at One Hundred and Ten Per Cent (110%) of their face plus accrued interest, provided that thirty days' notice of such redemption shall.be given the holders thereof, by notice published once a week for four consecutive weeks prior to such redemption, in a newspaper in New York City. If said bonds are registered, then a copy of the said notices shall be sent to the post office address of the parties in whose names said bonds are registered. Whenever it is desired to redeem any of said bonds, the Board of Directors of the Compressor Company shall pass a resolution setting forth the amount of bonds (at their par value) desired to be redeemed. The President of the Compressor Company shall thereupon draw by lot the numbers of the bonds to be redeemed, and he shall thereupon certify that such bonds were drawn for redemption, which certificate shall be entered upon the minutes of the Compressor Company, and a duplicate copy shall be delivered to the Trustee. Said bonds having been so drawn for redemption shall become due and payable on the succeeding interest payment date, provided that the date of first publication and the date of mailing notice to registered holders of bonds hereinbefore provided for shall have been not less than thirty days prior to such interest payment date, and the said bonds shall from such interest payment date, cease to draw interest, and the said Compressor Company may, upon the deposit of the proper amount with the Trustee, be privileged to consider said bonds as paid and canceled. Sixteenth The Trustee may resign the trust hereby created upon giving sixty days' notice in writing to the Compressor Company. In case of the resigna- tion of the Trustee, or of its dissolution, or insolvency, or removal for cause as Trustee hereunder, it shall be the duty of the Compressor Company to call a meeting of the bondholders by printed notice, published in two of the public newspapers of New York City, once a week for three consecutive weeks next preceding such meeting, calling such meeting to be held in the said City of New York, and by mailing notice of the same to each of the registered bondholders not less than ten days before the date of such meeting At the time and place specified in such Ch. 25] BOND ISSUES THE DEED OF TRUST 1631 notice, the holders of said bonds, in such meeting assembled, shall organize and proceed to elect a suitable corporation to act as Trustee under this agreement, and a majority in amount of such bonds legally represented at such meeting shall be competent to elect such new Trustee, and the corporation so elected shall im- mediately upon election and on its acceptance in writing of such trust become vested with all the estate, trusts, rights, powers, and duties of the present Trustee herein, and shall be entitled to receive from the present Trustee or its legal representatives all moneys, mortgages, and assurances appertaining or relating to this trust and the due execution thereof. Seventeenth It is covenanted and agreed by the parties hereto, and all the holders of bonds hereunder, as conditions precedent to the acceptance of the said trust by the said Trustee, or any successor thereto, as follows: The Trustee shall not be answerable for any act, default, neglect, or mis- conduct of any of its agents or employees, by it appointed or employed, in connec- tion with the execution of any of the said trusts, nor in any other manner answerable or accountable, under any circumstances whatsoever, except for bad faith. The recitals contained herein, or in the bonds, as to priority of lien, or any other matter whatsoever, are made by and on the part of the Compressor Company, and the Trustee assumes no responsibility for the correctness of the same. It shall not be the duty of the Trustee to file or record at any time this deed of trust or any other mortgages or deeds of trust that may be required hereunder, nor to do any other act or acts suitable and proper to be done for the creation or continuance of the lien or liens thereby intended, nor to effect insurance against fire or explosion, nor to renew any policies of insurance, nor to keep itself informed as to the payment of any taxes or assessments, nor to require such payments to be made. The Trustee may, however, in its discretion, do any or all of these things. Neither shall the Trustee be held responsible for the nature or amount of the security mortgaged to it here- under. The Trustee shall not be compelled to take any action, as Trustee, under this mortgage, unless properly requested and in every respect indemnified to its full satisfaction. The Trustee shall be entitled to reasonable compensation for all services rendered hereunder or in connection with the trust. This compensation, together with any and all necessary and reasonable expenses, charges, counsel fees, and other disbursements incurred by the Trustee in the discharge of its duties, as such, shall be paid by the Compressor Company, or out of the trust estate upon which they are hereby made a lien, prior to that of the bonds issued hereunder. The Trustee shall be protected in acting upon any notice, consent, request, certifi- cate, bond, or other paper or document believed by it to be genuine and for its due authentication by certificate of the bonds issued hereunder, and for the custody and disposition, as herein provided, of the securities and moneys received by it hereunder. Eighteenth It is covenanted and agreed between the parties hereto that the words "Compressor Company" when used in these presents mean the party issuing the bonds herein referred to; that the word "Trustee" means the corporation charged with the execution of the trust herein, whether the same be the Securities Trust Company of the City of New York, or any successor or successors in the trust hereby created; that the word "bonds" means the bonds issued hereunder; and the words "Trustee," "bond," "bondholder," and "holder" shall include the plural as well as the singular number and the term "majority" shall signify the majority in amount. Nineteenth It is covenanted and agreed that this indenture may be executed in several counterparts, each of which so executed shall be deemed to be an original, and such counterparts shall together constitute but one and the same instrument. IN WITNESS WHEREOF, the Maxwell Compressor Company has caused its corporate name to be hereunto subscribed by its President and its corporate seal to be affixed and attested by its Secretary, and the 1632 CORPORATE FORMS [Bk. IV- Securities Trust Company of the City of New York, in token of its acceptance of the trust hereby created, has caused its corporate name and seal to be hereunto affixed by its President, and attested by its Secretary, on this twelfth day of November, one thousand nine hundred and twenty-one. MAXWELL COMPRESSOR COMPANY, f CORPORATE \ By HOWARD M. MAXWELL, \ SEAL / President Attest: FRANK PAULSON, Secretary SECURITIES TRUST COMPANY / CORPORATE \ OF THE ClTY OF NEW YORK, \ SEAL / ,4s Trustee By MALCOLM McDouGALD, President Attest: FRANK G. COOPER, Secretary (Notarial acknowledgment by president of each corporation as given in Form 236.) It will be understood that the preceding form has, on account of space limits, been reduced to its simplest terms. It is, how- ever, a good working model and will afford a basis upon which to build up a more elaborate instrument when required. Part V Corporate Records, Reports, and Calendar CHAPTER XXVI MISCELLANEOUS BOOKS AND RECORDS In cases where an extensive stock-selling campaign is under- taken, a record of the sales and the cost of selling may be advan- tageously kept in a subscription journal. Such a campaign may be continued for a considerable period and in that case the columns of receipts and of commissions may be footed and posted daily or weekly as convenient. The form given below is self-explanatory. The instalment book is used when an instalment falls due, or when a call or assessment is decided upon by the board of directors. As will be seen by reference to the form which follows, it contains a list of the subscribers, the number of shares subscribed by each, and the amount of the instalment due, together with other information relating to the particular instal- ment. A new page or sheet is made out for each call or instal- ment. Instead of rewriting the names for each of these, the same list may be utilized by ruling up the page with groups of columns, each group adapted for one instalment; or by the use of long and short leaves. Any such arrangement may cause some little inconvenience in case subscription rights and instalments are transferred, thereby necessitating changes of names. The first column of the instalment book indicates the folio of the stockholders ledger in which the subscribers' accounts are recorded, payments being posted from the instalment book to the credit of the respective accounts. The last column preceding 1633 1634 CORPORATE FORMS [Bk. IV- C O S W o 1 CO o 3 N H O : : : : : >i alJiltHJI: : : /nii* CoMMissir LESMAN < 'Z O w o O co 0. o ::::::::::::: 2 et o ::::::::::::: C/2 M :::::::: O in ::::::::::::: Id 1 ::::::::::::: ............. u g Z H Ch. 26] MISCELLANEOUS BOOKS AND RECORDS 1635 8 & 1 in in M 1 ) m o H- o w ooo.oo 6 o o d o o <( '/> O f) o ON w a P) I f . M IS * ' u : 1 g H H o O o c M 2< o o o O o o d S S H c O C CJ n z ^ < g S S o < o o o o o o 8 Vj M | 5 w M H o d a. d rt 0, -r* ^ ^ .a u 1 f '^> w jn r! S ^j ", < to rt & ~ arren u- XI J3 IB s i * < * n 4 a w z P U i ^ lennett lompson tmor rguson o J o < -- "3 O &H '* o > .j S - 8 ^ ffi w J5 ~ in (/) U .3 a H S M Q Q u "O 1 * Id K 8 < H y o . S (1 X Ef ra jj g 3 * o P < w S C . '( ' C1 M 3> % ( j*f i- ( rt ' , TRANS- FER 1 M 1636 CORPORATE FORMS [Bk .IV- the remarks column indicates the cash book folio to which the payments may be carried in total each day, these payments being credited to "Capital Stock," "Capital Stock Subscribed" or "Subscribers," according to the plan of opening entries used. Since instalments on subscriptions are not necessarily paid on their due date, it is advisable to carry the total of each day's receipts to the cash book, instead of waiting until all are paid. It is obvious that an account for "Subscribers" must be opened in the general ledger and charged with the aggregate amount of the subscriptions due at that particular date. The same pro- cedure is required for each succeeding instalment. The instalment book is compiled from the various subscrip- tion sheets or individual subscription blanks, and may be either a bound or loose-leaf book. Loose sheets serve the purpose nicely, since they can afterward be bound together for filing. In a large corporation where many transfers are made, a transfer register similar to that shown below may be used to advantage. In a small company where transfers are not numer- ous it would not be necessary; and the postings may be made from the usual transfer book ' or even from the stock certificate book. The object of keeping the transfer register is to have a convenient medium through which postings may be made to the stock ledger, in which the transferrer is debited and the transferee is credited. It is not usual to have a bound book for the record of divi- dends, but loose sheets are used which may be bound together later. The sheet should show the names of the stockholders, date of dividend, number and amount of check. The form given below is for use where the stockholders come to the office in person, receive their checks and receipt for payment. Some small companies prefer this plan as it keeps the stockholders in closer touch with the business. 1 Form 85. Ch. 26] MISCELLANEOUS BOOKS AND RECORDS 1637 SI 2 w u o w s *S o 2 o < x, BJ O pa u u x to U O z < MOUNT OF [VIDEND O M < Q u a. o 5 w Z w H Jt *> w i ^ . t""^ H-H Id i ^. *^J 5 a cd ^"^ a 11 i ^^ ^*^ 1 M I pj C3 a j ^3 o 1 Q i 5 b ^ O in 9 I z & rj- C" ^X l ^O g M X "Z O Q g fc, u S , . QJ (3 o c3 ^ J 1 O (s, B! || PH ^ Jj 13 ^ / "S^ 03 frl *o ^j K* ^ " w 1 O rt ^ d> rj ^ "S S " s 53 HH eg p^ d e SE ORDER CHECK ) BE DRAWN IF NT FROM THAT OF OCKHOLDER T O j B 1- K D %^ |1 H^Q W *g^3 *^ t/5 V Q C 1^ iJ o n *T^ ^~* P O Q 5 ^ y 5 -^ M ' "^T^ CM co ^r CO CO CO Ch. 26] MISCELLANEOUS BOOKS AND RECORDS 1639 LJ CD I cs r. eo oj 8 8 8 . a a a -. CM en v ..',. a T i i i i S i 8 8 S - 8 a -\ *- a 1640 CORPORATE FORMS [Bk. IV- In most corporations the dividend checks are sent out by mail. In such case the dividend sheet shown in Form 258 will be found convenient. The list is usually made up from the stock ledger after the dividend is declared and after the transfer books have been closed. Under this plan the checks are made payable to the order of the stockholders and mailed to them. The indorsement on the back of the canceled check is considered sufficient evidence of payment. If in a bond issue the bonds are sold direct by the corporation, it must keep a detailed record of sales and for this purpose a bond register is necessary. This provides space for the name and address of the holder, the number of his bond, the date it was acquired, the party to whom transferred, and columns for the interest payments. The bonds are usually entered in numerical order, and in addition the number of the bond and the name of the owner are kept in a card index, from which it is pos- sible to trace up the ownership and transfers of any particular bond. When a registered bond is transferred the procedure is similar to the transfer of a stock certificate. The surrendered bond is canceled and filed, and the old entry in the bond register is can- celed by ruling a red ink line through it as shown on the form below. The name and address of the new owner is then recorded on the first vacant line on the page, and the record of transfer is complete. The difference between the footings of the "Amount" columns of the bond register and the sum total of all bonds canceled which is obtained by adding together all amounts through which the red ink line is drawn should agree with the balance of the Bond account in the general ledger. The list of bondholders and transferees may be kept in a book or on cards in an ordinary card index. The form given below is adapted for either method. One card or one blank is used for each bond issued. Ch. 26] MISCELLANEOUS BOOKS AND RECORDS Form 260. Index of Bondholders 1641 BOND NO. Eti-55 AMOUNT. NAMF / CLASS BONDHOLDER'S ADDRESS Post Office County State Street and No. TRANSFERRED TO Name Address Transferred From Form 261. Coupon Register E 455 METROPOLITAN INVESTMENT CO. BOND REGISTER $1,000.00 6% TRUST BOND Dated Jan. i, 1922 Due Jan. i, 1932 First Coupon due July i, 1922 20 15 IO 5 19 14 9 4 18 13 8 3 i? 12 7 2 16 II 6 Canceled Coupon 1642 CORPORATE FORMS [Bk. IV- Coupon bonds registered as to principal are entered in the bond register, and an alphabetical card index of bondholders is provided for each denomination of bonds issued. A coupon register is also necessary for the proper record of paid coupons. An entire page of the coupon register is required for the record of each bond. The number, the amount, and a brief description of the bond are entered at the top of the page. As each coupon is redeemed, it is pasted on the space bearing its number. A glance at the page will, at any time, show what coupons have been paid and which are due and unpaid. CHAPTER XXVII REPORTS Under the laws of most of the states corporations are com- pelled to make certain reports to the authorities, mainly for pur- poses of taxation. The federal income tax report is shown in some detail elsewhere. 1 The local forms vary so widely in the different states that they cannot be shown in the present volume. This chapter is therefore entirely confined to the reports made to the stockholders. The forms given are merely suggestive, as such reports will necessarily vary and vary widely with the conditions. The usual annual reports submitted to the stockholders are those of the president and treasurer. The president's report is intended to give a general review of the company's operation during the preceding year and a statement of its condition at the time of the report. It is usually the most important of those made to the stockholders at the annual meeting. In many cases it is the only formal report made, and then it will include the financial statements that would otherwise be given in the report of the treasurer. Any matters pertaining to the progress of the corporate business are properly brought out in the report of the chief executive officer. The annual report that is presented below includes a state- ment of the company's financial condition on the date given. It is a good typical example of a brief, but nevertheless compre- hensive report. It was mailed to all the stockholders of the company. Book III, Ch. XXXVI. "Federal Income Tax Returns.' 1 644 CORPORATE FORMS [Bk. IV Form 262. President's Annual Report TO THE SHAREHOLDERS OF THE STANDARD SANITARY MFG, CO. Pittsburgh, Pa., February I, 1922. In submitting to you herewith the Twenty-Second Annual Report of the Company's business covering the year ending December 31st, 1921, 1 am pleased to be able to state that we have made substantial progress during the year and that the financial condition of the Company, as well as the outlook for the present year, is very promising. The Balance Sheet, Profit and Loss Account, and other figures submitted by the Treasurer show that the financial condition of the Company is excellent and that we are in every respect equipped to take care of the large volume of business we have reason to believe the present year will bring to us. The Financial State- ment follows herewith: FINANCIAL STATEMENT ASSETS Purchase of Properties $6,667,772.79 Potteries Plants and Equipment... 966.426.27 Store and Warehouse Properties $7,634,199.06 1,624,701.19 9,258,900.25 Cash 889,353.22 Accounts Receivable 5,686,800.10 Notes Receivable 264,767.81 Insurance Deposits 84,278.23 Miscellaneous Securities 7,964.00 6,933,163.36 Inventories and Goods in Transit 7,319.336.20 Total Current Assets and Inventories 14,252,499.56 Investment in Standard Sanitary Mfg. Co., Ltd. of Canada 1,358,496.06 Pension Funds Invested 265,248.26 Employees' Stock Subscription Account __ 480,572.76 Furniture and Fixtures, Machinery, at other points than Factories, Trucks and Autos 369.718.88 Miscellaneous Items and Deferred Charges to Operations.. 142,706.1 1 Patents 1.00 $26,128,142.88 CAPITAL AND LIABILITIES INVESTED CAPITAL Common Capital Stock (Issued) $13,168,800.00 Preferred Capital Stock (Issued) 4,532,100.00 Surplus and Reserves Total Capital, Surplus and Reserves LIABILITIES AND OPERATING RESERVES Accounts Payable $1,563,709.28 Provision for Federal and State Taxes $521, 764-78 Preferred Stock Dividend payable Feb. 15, 1922... 79,311.75 Reserve for Contingent Liabilities.... 671,131.70 1 7.700.900.00 5,591,325.37 $23.292,225.37 2,835.917.51 $26,128,142.88 Ch. 27] REPORTS 1645 Quick Assets December 31, 1921, amounted to ... $14,252,499.5* Quick Liabilities December 31, 192 I, amounted to. 2,835,917.51 Proportion of Quick Assets to Quick Liabilities $5.02 to $1.00 NET WORTH Book Value of Common Stock per Share, December 3 f, 1 920 $136.52 Book Value of Common Stock per Share, December 31, 1921 $142.46 Net Worth of Company, December 31, 1921 $23,292,225.37 Common Stock earned in 1921, after deducting Federal Tax and Reserves 14.28% Common Stock earned in 1920, after deducting Federal Tax and Reserves 22.74% EARNINGS Earnings of the Company for the year ending December 31, 1921, were $3,057,016.52, Less Amounts set aside, viz: To make Contingent Reserve equal _ $150,000.00 $139,519.60 For Pension Fund Reserve. 25,000.00 To make Reserve for Bad Accounts and Unadjusted claims equal the sum of $125,000.00 5,995,85 For Federal Taxes.. 503,357.63 For Preferred Stock Dividends 316,772.75 For Extra Compensation to Executive Committee _ 85,812.75 For Reserve for probable shrinkage of Capital Assets, acquired at excessive cost since 1915. 100,000.00 $1,176.458.58 Amount added to Surplus out of 1921 earnings and appli- cable to Common Stock _ $1,880,557.94 Dividends paid on Common Stock during the year, 9% $1,111 ,064-00 Dividends paid on Preferred Stock during the year, 7% 315,861.00 Total Cash Dividends paid in 1921 $1,426.925.00 DEPRECIATION Total depreciation charges for the year amounted to $466,615.97 as against $365,426.04 for 1920. These figures do not include the additional reserve set up each year for "Probable shrinkage of Capital Assets acquired at excessive cost since 1915" and which amounted to $250,000.00 in 1920 and $100.000.00 in 1921. SALES Volume of sales for the year show a decrease of 23% as compared with the previous year. Branch House Sales show a falling off of 31%, while sales of our manufactured product were reduced only 12%. Part of this reduction is due to lower values caused by declines Jn prices on nearly everything we manufacture or handle. 1646 CORPORATE FORMS [Bk. IV- MANUFACTURING PLANTS We were not able to keep our Plants operating full capacity during the year. This was particularly true of our Potteries and Brass Plant. On Enameled Iron Ware the demand was better and we produced about the same tonnage as in the previous year. We expended in improvements and extension of our Plants during 1921 the sum of $1,335,723.84. The physical condition of our Plants Is first class. We have made satisfactory adjust- ments with our labor and we are beginning the new year with all Plants running full time. BRANCH HOUSES Owing to the general business depression which existed during 1921 our Branch House business was unsatisfactory. We suffered heavy losses through declines in merchandise in- ventories and were not able to reduce overheads in proportion to decrease in volume. Salaries, which amounted to one-half of our Branch House Expense, were not reduced at all. All this resulted in Branch House Profits being the smallest in years. We expended in Branch House and Warehouse additions during the year the sum of $230,614,00. EMPLOYEES AND PAYROLLS Number Salaries or Wages Paid Plants _ 5044 $7, 1 73,456.65 General Offices and Sales Offices __ 379 783,380.69 Branch Houses 992 1,592,735.85 6415 $9,549,573.19 Average per employee 1920 _ _ $1,644-04 Average per employee 1921 - 1,488.63 CROUP LIFE INSURANCE Employees insured _ __ _ 5250 Total amount of all policies carried _ $5,872,950.00 Number of deaths during year _ _ _ 34 Amount paid to Beneficiaries _ $ 39,584.15 Amount paid to 3 employees under Disability Clause _ _ $ 2,850.00 Total premiums paid by Company. .-.._ _ - $ 59,972.95 SHAREHOLDERS On November 4th the total number of Shareholders in the Company, exclusive of Em- ployee Shareholders who have subscribed for stock under our plan of February 21st, 1921, amounted to _ _ 994 438 Women and 38 Estates and Trusts owned 84,972 shares out of a total of 1 71 , 1 36 shares. It will be seen that practically one-half of the Company's stock is held by Women, Trusts and Estates, showing that Standard Sanitary Manufacturing Company Stock has now become an investment security. The officers of the Company appreciate the confidence this implies, and are mindful of the responsibility thereby imposed. Ch. 27] REPORTS 1647 EMPLOYEE SHAREHOLDERS At the beginning of the year we had 99 Employees, exclusive of the officers of the Company, who were Shareholders. On February 21st, 1921, the Company offered to its employees 5000 shares of Common Capital Stock and 1000 shares of Preferred Capital Stock under certain favorable condition*. On this offer we received subscriptions as follows: 1518 subscriptions to Common Stock, totaling _ 6315 shares 121 subscriptions to Preferred Stock, totaling _ 306 shares As some subscribed for both Common and Preferred the total number of subscribers amounted to . 1571 As the stock was over-subscribed the larger subscriptions were scaled down, and no em- ployee received more than 1 shares in the final distribution. 22.26% of our employees subscribed to this stock issue, which we consider very favorable. At the end of the year 1295 subscribers retain their subscriptions for 4250 shares of Common and 2 1 6 shares of Preferred Stock, on which they are paying in regular installments $3.00 monthly on each share of stock. 82 employees have paid their subscriptions in full. 194 employees have for various reasons cancelled their subscriptions. The unpaid balances of the employees' subscriptions on December 3 1st, 1 92 1 amounted to $480,572.76 The Company now has 1 394 employees on its list of Shareholders, 2 of whom are on the Pension Roll. By interesting our employees as shareholders we hope to accomplish two things: First: To give the employee an opportunity to become a partner in our enterprise by gradually accumulating a substantial stock interest, and through that sharing in the profits of his own labor as well as that of his fellow employees. Second: Putting the Company on a safer and firmer basis since we now have 1394 partners who have the interests of the Company at heart and will give us their best efforts to promote the Company's welfare. In doing this we are following the tendency of the times and the example set by numerous other large industrial concerns. CANADIAN COMPANY Our Canadian Company reports a falling off both in Sales and Profits for the year. The demand for our product has been very light and we have been able to operate the Plant only with a reduced force and on part time. The earnings for the year are not taken over on our books and therefore not included in our Profit and Loss Statement. IN GENERAL While the results of our 1921 business were not as good as we expected we feel by com- parison with other industries that we have done very well. We earned and paid our regular dividends on Preferred and Common Stock, and increased the Surplus Account $1,124,503.90. Jf the long looked for revival in building occurs during 1922 we are in position to meet the demands that may be made on us and to largely increase the output and sale of 'Standard" Products' Respectfully submitted, For the Board of Directors, 1648 CORPORATE FORMS [Bk. IV- The following extract from the 1922 annual report of the United States Steel Corporation shows the detail into which annual reports of the larger corporations go on some points. This report was submitted to the stockholders of the company by the chairman of the board, Form 263. Report on Employees and Pay-Rolls The average member of employees in the service of all companies during the year, and the total salaries and wages paid in comparison with corresponding results for the preceding year, were as follows : 1921 1920 EMPLOYEES OF NUMBER NUMBER Manufacturing Properties 133,963 200,991 Coal and Coke Properties 22,451 25,889 Iron Ore Properties 11,183 II ,Si7 Transportation Properties 20,010 24,643 Miscellaneous Properties 4,093 4,305 Total 191,700 267,345 Total Salaries and Wages Paid $332,887,505 $581,556,925 Average Earnings per Employee per day during 1921 : All employees, exclusive of General Administrative and Selling force $5.61 $6.96 Total employees, including General Administrative and Selling force $5-73 $7.00 In many corporations, as stated earlier in the chapter, the treasurer makes no independent report, the president's report covering the general affairs and condition of the corporation, including its finances, together with any plans for the future. Where but one formal report is made to the stockholders and this report is made by the president, the treasurer or comptroller will of course supply the material for the financial portion of the statement. When independent reports are submitted to the stockholders by the president and the treasurer, the individuals making these reports should work in sufficiently close touch to prevent any serious overlapping. When the treasurer or comptroller makes an independent annual report to the stockholders, he should include in it such financial details as the directors deem expedient for the stock- Ch. 27] REPORTS 1649 holders to know, or, to express it otherwise, all such financial details as will be of interest to the stockholders, and which will not by their publication injure the company's business. The treasurer's report may be informal, merely covering the general financial results of the year's work. Or it may be a more or less detailed statement of the company's financial con- dition. Almost always it takes the form of an income statement followed by a complete balance sheet. The following income statement of the Western Electric Company is, as will be noted, issued by the comptroller of the company. It appears in connection with the president's annual report, but is not incorporated with that report. It is a highly condensed statement, merely showing the figures of greatest interest to the stockholders. Form 264. Treasurer's or Comptroller's Report Statement of Earnings Including the owned subsidiaries, WESTERN ELECTRIC COMPANY, INCORPORATED, OF DELAWARE WESTERN ELECTRIC COMPANY, INCORPORATED, OF CALIFORNIA EARNINGS FOR TWELVE MONTHS ENDING DECEMBER 31, 1921 Sales $189,764,814 Other Income 2,892,499 $192,657,313 Cost of Merchandise $168,565,875 Expenses 12,207,613 Taxes 1,717,488 182,490,976 Available for Interest and Dividends $ 10,166,337 Interest Paid and Amortization of Bond Discount. .$ 5,842,340 Dividends: On Common Stock, $10.00 per share, 350,000 shares outstanding 3,500,000 9,342,340 Balance carried to Common Stock $ 823,997 R. H. GREGORY, Comptroller 1650 CORPORATE FORMS [Bk. IV- Form 265. Treasurer's or Comptroller's Report Balance Sheet BALANCE SHEET DECEMBER 31, 1921 Assets Real Estate and Buildings $19,354,501 Machinery and Equipment 26,215,335 Total Plant $ 45,569,836 Merchandise $ 28,978,025 Cash 13,262,880 Bills Receivable 779,019 Trade Acceptances 573,474 Marketable Securities 833,268 Accounts Receivable 39,O35,9 2 7 Total Current Assets 113,462,593 Trustees, Employees' Bond Purchase Plan 465,464 Sundry Investments 2,315,471 International Western Electric Company, Incorporated, of Delaware 1 7,988,053 GRAND TOTAL $179,801,417 Liabilities Preferred Stock, 7%, 500,000 Shares Authorized, None Issued Common Stock, 500,000 Shares Authorized, 350,000 Shares Issued, No Par Value $ 58,773,450 First Mortgage Bonds, 5%, 1922 15,000,000 Convertible Gold Bonds, 7%, 1925 28,600,000 Total Capital Liabilities $102,373,450 General Bills Payable $29,050,000 Trade Acceptances and Bills Receivable Discounted . 448,456 Accounts Payable 13,586,093 Total Current Liabilities 43,084,549 Reserve for Depreciation on Plant $27,924,413 Reserve for Employees' Benefit Fund 1,600,000 Reserve for Contingencies 4,819,005 Total Reserves 34,343,418 GRAND TOTAL $179,801,417 R. H. GREGORY, Comptroller Ch. 27] REPORTS 1651 The foregoing balance sheet is also presented to the stockhold- ers of the Western Electric Company by its comptroller, showing the assets and liabilities of the company as of December 31, 1921. In the larger corporations there are usually one or more standing committees appointed from the board of directors, such as the executive committee which exercises the general authority of the board in the interim between its meetings, and the finance committee which has general supervision of the financial affairs of the company. The standing committees do not usually report to the stockholders, their reports being made to the board of directors and the matters under their supervision being usually covered by the president's and the treasurer's reports respec- tively. There is no special form for committee reports. A clear statement of what they have accomplished, addressed to the stockholders or the directors as the case may be, and signed by the members of the committee or by the chairman for the com- mittee, is all that is required. A committee report, unless of considerable length, is usually presented and read. If too lengthy to permit of this, and of sufficient importance to justify the expense, it is printed for distribution. Form 266. Report of Committee on By-Laws TERREBONNE CEMENT COMPANY REPORT OF COMMITTEE ON BY-LAWS To the STOCKHOLDERS of the TERREBONNE CEMENT COMPANY GENTLEMEN: Your committee appointed at the last annual meeting of the stockholders to report any needed modification in the By-laws of this Company, begs to submit the following: 1. We would recommend the addition of a by-law providing for an Executive Committee, to consist of three members of the Board of Directors, such Committee to have full control of the general business affairs of the Company in the interim between meetings of the Board. 2. We would recommend that the present by-law relating to the regular meet- 1652 CORPORATE FORMS [Bk. IV- ings of the Board of Directors be so changed as to provide for quarterly meetings instead of monthly meetings as at present. 3. We strongly disapprove of the suggested amendment to the by-laws whereby the president is given authority to sign checks, as we believe such change to be not only unnecessary but against the interests of the Company. Respectfully submitted, JAMES F. GOUGH, HARKNESS H. LEWIS, OLIVER H. SIMPSON, Committee on By-laws New York City, January 15, 1922 CHAPTER XXVIII THE CORPORATE CALENDAR The corporate calendar is an orderly statement of the impor- tant corporate formalities that must be attended to at fixed periods, so arranged that the secretary may at any time, by a mere glance, see just what corporate' duties require his attention. The amount of detail entered on the corporate calendar will vary according to the preference of the particular secretary, from a mere skeleton outline of the reports and notices required by the statutes and by-laws, to a fairly complete digest of corporate procedure. It is advantageous to enter reasonably full details, as much subsequent research may thereby be avoided. The corporate calendar is frequently entered in the minute book. More conveniently it is prepared on a special card or cards, or on a desk calendar, in either case so placed or hung that it is plainly in sight. Or if the minute book plan is preferred, a small skeleton calendar or "tickler" may be prepared in addition, which, kept on the desk, will call attention to the dates upon which the calendar in the minute book should be consulted. The calendar which follows is given merely to show the general plan and the matter which is usually included. It is arranged for a New York corporation having its principal place of business in the City of New York and holding its annual meeting of stockholders on the third Wednesday of January at 10:30 A.M., with quarterly meetings of directors on the third Thursday of January, April, July, and October, at 4 P.M. Its by-laws require ten days' notice of annual meetings, and five days' notice of directors' meetings. Its stock book is closed fifteen days before the annual meeting. It will be noticed that under this arrangement the January 1653 1654 CORPORATE FORMS [Bk. IV- directors' meeting will usually fall on the day following the annual meeting at which directors are elected. If, then, this election is duly held, the regular notice of the directors' meeting is of no effect as to the newly elected directors, and if the by-laws are mandatory as to notice, the meeting must be postponed or omitted, or the secretary, disregarding the notice already given, may provide for the meeting of the board on the proper date by means of a call and waiver signed by all the newly elected directors. In the calendar which follows,the date for each corporate act, as filing reports, payment of 'taxes, etc., is in most cases entered fifteen days in advance of the last day allowed by law, while a memorandum is also entered as a precautionary measure on the last day. Thus, a report that may be deferred if desired until the 3ist day of January, is entered on the calendar under date of January 16. This is a matter that may be varied to suit the individual. - Form 267. Corporate Calendar (New York) CORPORATE CALENDAR of the FARWELL MACHINE WORKS of New York City 1922 January 1. Last Day for payment of State Income Tax, or 30 days after notice of assessment, if notice is given after December 3 1 . 2. Close Transfer Books for annual meeting of January 18, 1922. 4. First Publication of notice of annual meeting of stockholders in accordance with Sec. 25 of the Stock Corporation Law. (Publica- tion may be dispensed with if waived in writing by every stock- holder of the corporation.) 8. Mail Notice of annual meeting to each stockholder of record at his last known post-office address. 10. Second Publication of notice of annual meeting of stockholders. 14. Notify Directors of meeting to be held January 19. If Directors are elected at annual meeting (January 18), this notice will be vitiated as to all directors elected at such meeting and must be replaced by Ch. 28] THE CORPORATE CALENDAR 1655 waiver of notice signed after election by all the newly elected directors. 15. Franchise Tax Payable. Must be paid before February 14. Based upon November report to State Tax Commission. Checks should be made payable to State Treasurer. (This is payable only by realty, holding, and public service corporations.) 16. Annual Report to State officials. Must be filed during January, and not later than January 31, with Secretary of State. No filing fees. Blanks not supplied by officials. No penalty incurred for omission of the report unless such filing is requested by some stockholder or creditor of the Company, and not then if the report is filed within 30 days after the request is made. 18. Annual Meeting of stockholders at 10.30 A.M. (Held pursuant to notice sent out January 8.) 10. Directors' Meeting at 4 P.M. If directors were elected at annual meeting, waiver of notice should be signed by each new director. 31. Last Day for filing annual report. February 13. Federal Income Tax Report must be filed on or before March 15. Prepare data. 14. Last Day for payment of State Franchise Tax without penalty. March 15. Last Day to file Federal Income Tax Report. One-fourth of the tax must be paid at this time. April 14. Notify Directors of meeting to be held April 19. 15. Tax Bill for Taxes on any real estate in New York City should be secured from the Receiver of Taxes, in the borough where the property is situated. 19. Directors' Meeting at 4 P.M. May i. New York City Taxes Payable. Statement of amount may be obtained from Assessor's office. One-half must be paid before May 31. One-half of taxes on real property may be deferred till November i next. June i. New York City Taxes. If not paid, interest at 7% from May i will be added on all Personal Taxes and the first half of the Real Estate Tax. 15. Second Payment of one-fourth of Federal Income Tax due on or before this day. State Income Tax Report must be filed on or before July i with the State Tax Commission. The tax will be due January i in next year. July i. Last Day to file State Income Tax Report. 14. Notify Directors of meeting to be held July 20. 20. Directors' Meeting at 4 P.M. 31. Last Day to file return for United States Capital Stock Tax. This tax is payable within 10 days after receipt of Notice of Assessment from Collector of Internal Revenue for district. September 15. Federal Income Tax. Last day to pay third quarter of Tax to Collector of Internal Revenue for District, i6 5 6 CORPORATE FORMS [Bk. IV- October November December i. New York City Real Estate Tax. The books showing assessed value? are open to inspection at offices of Department of Taxes and Assessments in each borough. Applications for corrections must be made on forms furnished by Department on or before November IS- 13. Notify Directors of meeting to be held October 19. 19. Directors' Meeting at 4 P.M. i. Real Estate Tax. Second half of New York Real Estate Tax due. Must be paid before 3oth. Franchise Tax Report. Must be sent in for realty, holding, and public service corporations on or before November 15. Blanks furnished by and report made to State Tax Commission. No filing fees. Penalty may be incurred by failure to make this report. 15. Last Day for filing application for revision of real estate assessment. 30. Last Day for payments of second half of Real Estate Tax. i. Real Estate Taxes. If second half of Real Estate Tax is not paid, 7% interest will be added from November i. 15. Federal Income Tax. Last quarter of tax is due. 16. State Income Tax payable on or before January i. INDEX ACCEPTANCES (See "Trade Acceptances") ACCOUNTING. No-par value stock, 129 Relation to finance, 557 ACCOUNTS (See also special kinds of accounts) Corporate, Nature of, 1033 Peculiarity of, 1036 Juggling of, 979 ACCOUNTS PAYABLE, Credit secured on, 858 ACCOUNTS RECEIVABLE, As collateral security, 864 Purchaser of, 715 Stock not paid in full as, 1076 ACKNOWLEDGMENT, Charter application, 208 Corporate, form, 1605 ADDRESS, CORPORATE, Not necessary on charter, 190 ADJOURNMENT, Annual meeting, 350 Directors' meetings, 367 Special meeting, 357 ADMINISTRATORS, Stock transfer by, 315, 317, 319 Votes, 135 ADVERTISING, Sale of investments, 824 ADVERTISING AGENCIES, Financial plan, 734 AFFIDAVITS, Forms, 1598-1605 AFFILIATED AND SUBSIDIARY CORPORATIONS, 593 Accounting, when consolidating, 1278-1295 Collateral trust bonds, 632 Consolidated balance sheet, 1373-1383 (For full list of subjects see "Consoli- dated Balance Sheet") Dividends for holding company, 1381 Intercompany ownership of stock on con- solidated balance sheet, 1376 Ownership of bonds on consolidated bal- ance sheet, 1376 AFFILIATED AND SUBSIDIARY CORPORA TIONS Continued Status of, 1269 Valuation of stock of, 1136 AFTER- ACQUIRED PROPERTY CLAUSE, 615 AGENT (See also "Transfer Agents and Registrar") Defined, 4 Law of principal and, 4 May be removed by directors, 149 Signature, Form, 1587 Stock transfer by, 315, 317, 318 AGREEMENT, Directors', for consolidation, 1286 Incorporation, 44, 1172 Syndicate, 842 To purchase stock not a subscription to stock, 37 Voting trust, Form, 1517 AMALGAMATION (See "Consolidation") AMERICAN HARDWOOD MANUFACTURERS' ASSOCIATION, 521 AMERICAN LOCOMOTIVE COMPANY, 944 AMERICAN WOOLEN COMPANY, Underwriting plan, 846 AMORTIZATION, Anticipation of redemption dates, 1222 Bond discount, 1216-1224 Bonds outstanding method, 1220 Effective rate method, 1218 Equal instalment method, 1219 Leaseholds, 1265 Operation of various methods 1222 Principles, 1216 Sinking fund methods, 656-659 ANNUAL TAX (See "Franchise Tax") ANNUITIES., Sinking fund, calculation, 1233-1235 APPLICATION, CHARTER, 208-211 APPRECIATION, Basis of capitalization, 664 Book entries, 1060 Objection to book entry, 1062 1657 1658 INDEX APPROPRIATIONS AND ESTIMATES (See "Bud- gets") ARIZONA, Incorporation in, 57 ARTICLES OF ASSOCIATION (See "Charter") ASSETS, Capital (See below under "Fixed") Current, Denned, 688 Investments in, 560 Ratio of, to current liabilities, 698 Distribution of, stockholders' rights, 137 Fictitious or watering, 1056 Fixed, Defined, 663 Investments in, 560 Surplus from sale of, 910 Intangible, Basis of capitalization, 665 Depreciation, 876 Liquidity of, as affecting working capital, 713 Preferred, 91, 607 Purchase of, to form consolidation, 518, 1278, 1289 Purchased for capital stock, 1060 Quick, defined, 688 Relation between, and security issues, 725 Revaluation, surplus from, 911 Sale of. Consent of stockholders required, 142 Profit or loss on realization, 1298 Secret, 1052 Surplus does not represent specific, 1045 Transfer of. In consolidation, 1286, 1289 In dissolution, 1300 Valuation, Book values, 1060 Partnerships incorporating, 499 Wasting, Depletion reserves, 1054 Dividends declared out of capital stock, 424 Sinking funds for bond redemptions, 660 Working (See above under "Current") ASSIGNMENT OF STOCK (See "Stock Transfer") ATTORNEY (See "Counsel") AUDITING, Annual, for protection of minority stock- holders, 491, 492 Retiring treasurer responsible for audit of books, 383 Stock ledger, 1073 AUDITOR, By-laws, 257 Duties and functions, 390 Relation to treasurer, 389 B BABY BONDS, 620 BALANCE SHEET (See also "Consolidated Balance Sheet") Forms, 1357-1360, 1363, 1650 Bonds on, 1370 Capital stock on, 1360 Federal Reserve Bank, Form, 1357-1360 Good-will on, 1371 No-par stock on, 1361 Partnership incorporated, 1183 Reserves on, 1368 Sinking und on, 1370 Subscription to stock on, 1361 Surplus on, 1038, 1364-1367, 1369 BALTIMORE AND OHIO RAILROAD, Exploitation of, 979 BANK DEPOSITS, By-Laws, 262 Form, 1472 Corporate depository delegated by direc- tors, 283 BANKERS (See also "Investment Bankers") As promoters, 773 BANKRUPTCY (See also "Insolvency") Involuntary, 1004 Nature of, 1003 Types of, 1004 Voluntary, 1004 BANKS, Capitalization of, 73 Charters, 169 Dividends, accounting procedure, 1154 Loans by, 858-866 Promoter's .connection with for prelim- inary financing, 765 Short-term notes handled by, 647 Sources for capital funds, 792 BETTERMENTS, Capital invested in, 942 Cause of insolvency, 996 Income statement, 879-882 BILLS OF LADING, As collateral security, 863 BOARD OF DIRECTORS (See "Directors") BOND HOUSE, Liability of, 826 Sale of Securities, 823-829 BONDHOLDERS, Assessment of, 1020 Index, 1187 Interests in reorganization, ion BONDS (See also special kinds, as "Debenture Bonds," "Mortgage Bonds," etc.' Forms, 1619-1624 B ONDS Continued Accounting, Accounts used, 1189 Amortization, 1216-1224 Authorized account, 1190 Balance sheet entry, 1370 Coupons, 1 202 Discount, 1213-1224 Discount account, 1192 Income from investments, 1212 Instalment payments, 1196 Interest account, 1192 Interest accrued, 1204 Interest charged to construction account, I2II Interest liability, recording, 1203 Interest on guaranteed bonds, 1209 Interest on income bonds, 1210 Interest on registered bonds, 1205 Interest on special issues, 1210 Interest on treasury bonds, 1208 Interest on two or more issues, 1206 Premium account, 1190, 1213-1223 Records, 1186, 1202-1212 Redemption, 1247-1257 (See below under "Redemption") Sale entry, 1195 Single bond account, 1191 Unissued account, 1190 Amortization, 1216-1223 As borrowed capital, 596 As collateral security, 862 Authorization, 449 Account, 1190 Baby, 620 Certification, 453 Classification, 461-465, 624-646 Collateral trust, 464, 631 Redemption, 1254 Sale, 1198 Common law, 449 Compared to preferred stock, 88 Convertible, 463, 642-645 Redemption, 1254 Coupon, 448, 452, 622 Form, 1621 Interest record, 1188, 1201 Records for, 1186, 1202 Debenture (See "Debenture Bonds") Deeds of trust, 453-456, 615 Forms, 1625-1632 Defaulted payments, 1257 Denominations, 619 Discount and premium, Accounting, 1191, 1192, 1213-1224 Accounting entries, 1217 Amortization, 1216-1223 BONDS Continued Discount and Premium Continued Anticipation of redemption dates, 1222 Bonds outstanding method, 1220 Capitalization, 684 Effect of market prices on, 1221 Effective rate method, 1218 Equal instalment method, 1219 Nature of, 1214 Operation of various amortization methods, 1223 Repurchase of own bonds at, 1241, 1251, Dividends paid by, 433, 435, 1153 [1254 Due date, stated on face, 1247 Equipment trust, 465, 629-631 Redemption, 1255 Sale, 1 200 Face value, 619 Gold, 463, 621 Guaranteed, 464 Interest record, 1209 Redemption, 1255 Sale, 1197 Income, 463, 638-641 Interest record, 1210 Indemnity (See "Indemnity Bond") Information stated on, 453 Interest, 622 Account, 1192 Accounting, 1202-1212 (See above under "Accounting") Accrued, 1193, 1195, 1204 [1213 Accrued, adjustment of, in selling price, Charged to construction, 684, 1211 Guaranteed bonds, 1209 Income bonds, 1210 Income from, 1212 Methods of paying, 1 202 In two or more issues, 1206 Records, 1186, 1188, 1202 Registered bonds, 1205 Special issues, 1210 Treasury bonds, 1208 Issued, Accounting entry for sale of, 1 195 At time of organization, 63 Defined, 1185 Nominally and actually, 1185 Issues, Closed or open, 617 Consolidations, 1287 Expenses, 1213 Interest on special, 1210 Interest on two or more, 1206 Size, 618 Terms of, 1185 To secure capital, 76 i66o INDEX B ON DS Continued Junior lien, 462. 625 Lost stock certificate, 305 Maturity, 621, 658 Due date stated on face, 1247 Failure to meet, 998, 1257 Names of misleading, 624 Nature of, 447, 612, 618 Outstanding, Defined, 1185 Nominally and actually, 1185 Retirement in consolidation, 1292 Participating, 645 Payable in foreign currency, 620 Premium (See above "Discount and Pre- mium") Price, 450 Purchase and sale (See also above under "Discount and Premium") Accounting, 1194-1201 Adjustment of accrued interest, 1213 At par and accrued interest, 1195 Collateral trust bonds, 1198 Discount entries, 1214 Equipment trust bonds, 1200 Expenses of issue, 1213 For sinking funds, 1241, 1251 Guaranteed bonds, 1197 In instalments, 1196 Mortgage bonds, 1194 Premium entries, 1214 Serial bonds, 1 200 Purchase money, 465 Redemption, 460 (See also "Redemption Funds") Accounting for, 1216-1224, 1247-1257 Anticipating dates, 1222 Calling in, by lot, 1248, 1250 Collateral trust bonds, 1254 Convertible bonds, 1254 Default in payment, 1257 Equipment trust bonds, 1255 Guaranteed bonds, 1256 Methods, 1247 Refunding at maturity, 1247 Refunding bonds, 1252 Repurchase and cancellation, 1241, 1251 Serial bonds, 1253 Short-term notes, 1255 Sinking fund, 457, 653-662, 1247-1250 Refunding, redemption, 1252 Register, Form, 1638 Registered, 448, 622, 1187 Interest record, 1188, 1205 Recorded for, 1186 Transfer record, 1187 BONDS Continued Rights of holders, 448, 459, 618 Salability of, 618 Sale, 458 Accounting, 1194-1201 Secured, 624-633 Security for, 624 Serial, 656, 658 Redemption of, 1253 Sale, 1200 Statutory law, 449 Stockholders' assent to issue, 449 Subscriptions, 1196 (See also ''Subscrip- tions") Terminal, 464 Transfer, 1187 Treasurer's (See "Treasurer, Bond") Treasury (See "Treasury Bonds") Trustee's certificate, Form, 1623 Unissued, Account for, 1190 Accounts, 1190 Sometimes called "treasury bonds," 1185 Unsecured, 634-646 Valuation, 460 Vendor or transfer against, liability of, 458 BONDSMEN, Liability of, 408 Personal, 405 Surety company, 406 BONUS STOCK, 93 Account, 1140 As a commission, 1174 Accounting treatment, 1177 No-par value, advantages, 1141 BOOK VALUE (See "Valuation") BOOKS, Corporate, 369, 1033 Minute book, 369-374 BOOKS OF ACCOUNT (See also special kind as "Journal," "Ledger," etc.) Combination record, 1035 Inspection of, by stockholders, 137, 484 Legal requirements, 1034 List of, 1035 Manufacturing corporation, 1157 Mining corporation, 1161 Requirements, 1034, 1157 Stock transfer, by-laws, 225 Subsidiary, 1035 Treasurer's duties in regard to, 381 BROKER, Liability of, 826 Sale of securities, 823-829 .BUDGETS, 922-935 Advantages, 923, 934 INDEX 1661 B UDGETS Continued Basis for, 930 Cash receipts and expenditures, 931, 933 Defined, 922 Expenses, 932 Flexibility, 928 Income, 932 < Income and expenditure, 931 Monthly, 929 Plan of, 561 Procedure, 923-926 Restrictions imposed by, 928 Sales estimates, 926 Secures singleness of purpose, 928 Yearly, 929 BUILDING CONSTRUCTION, Financing, 766 Interest paid on bonds during period of construction, 684, 1211 BUSINESS CORPORATIONS, Denned, 167 BUSINESS ORGANIZATIONS, Forms, 563 Dependent on the law, 3 BY-LAWS, 10 Forms, 1463-1473 Adoption, 220 Directors' power, 150, 195, 217, 218, 244 First stockholders' meeting, 273 Amendments, 264, 371 Form, 1466 Arrangement and classification of, 219 Assistant officers, 237 Assistant treasurer, 380 Auditor, 257 Bank deposits, 262 Books of account called for, 1034 Certificate of transcript, Form, 1602 Changes in, director's power to make, 195 Committees, 245-251 Report, form, 1651 Contractual feature, 264 Copy inserted in minute book, 371 Counsel, 256 Delegation of authority, 258 Directors, 235-244 Directors' meeting, 230-242 Notices, 240 Order of business, 244 Dividends, 260, 420 Election of directors, 232 Election of officers, 242 Ethics of contracts, 974 Financial committee, 387 Financial provisions, 260-265 Functions of, 215 BY-LAWS Continued Limitation of indebtedness, 261 List of stockholders, 231 Managing officers, 255 Officers, 252-259 Penalties for enforcement, 263 Power to make, 217 Preferred stock, 225 Pre-incorporation provisions, 44 Preparation, 220 President, 253 Presiding officers, 253 Provisions, 216 Provisions inserted in, to overcome diffi- culties of charter amendment, 206 Proxies, 234 Removal of officers, 259 Reserve funds, 260 Salaries, 258 Seal, corporate, 263 Secretary, 254 Standing committees, 245-251 Statutory provisions, 217 Stock, 222-227 Fractional share, 227 Transfer, 224 Stock and transfer books, 225 Stock certificates, 222 Loss of, 226 Stockholders, 228-234 Stockholders' meetings, Annual, 228-234 Notices of, 230 Order of business, 234 Presiding officers for, 230 Stockholders' rights in making, 141, 485 Subject matter, 216 Sundry provisions, 263 Transfer agent and registrar, 224 Treasurer, 255, 377-381 Treasury stock, 226 Vice-president, 253 Voting, 231 CALENDAR, CORPORATE, Form, 1654 CALIFORNIA, Face value of stock not discriminated against, 80 Incorporation in, 57, 58 Unfavorable laws for corporations, 53 Voting rights provide for no preference, 96 CALL, Special meetings, 352, 360 1 662 INDEX CALL AND WAIVER OF NOTICE, Directors' first meeting, 277 Form, 1507 Directors' special meeting, 363 Form, 1325 Stockholders' first meeting, 268, 272 Forms, 1501, 15^9 Stockholders' special meeting, 353 Forms, 1520 CAPITAL, Additional, secured by reorganization, 101 8 Borrowed (See also "Loans") Forms, 854-866 Advantages, 849 Defined, 595 Disadvantages, 852 Ease of securing, 851 Risks of, 852 Rules for, 853 Sources of, 851 Defined : 69 Fixed (See "Fixed Capital") Owned, defined, 595 Partnership a disadvantage in securing, 567 Requirements, Consolidations, 936 Estimating, 686-696 Sources of, Assessment of security holders, 1020 Customers, 803 Employees, 802 For small enterprises, 797 Funding floating debt, 1023 Investing institutions, 793 Investing public, 792 Investment associations, 794 Profits, 791 Sale of securities, 796, 799-822, 1019 Speculative public, 795 Stock subscriptions, 791 Stockholders, 799, 1020 Surplus, 918 Working (See "Working Capital") CAPITAL ACCOUNT, Nature of, 1036 Non-stock corporation, 1130 Surplus, 1058 CAPITAL ASSETS (See "Assets, Fixed") CAPITAL STOCK (See also "Certificates of Stock," "Common Stock," "Dividends," "Preferred Stock," "Retirement Funds," "Stock Transfer," "Treasury Stock") Account, Formal statement upon opening books, 1066 Ledger entry, 1072 Manufacturing corporation, 1158 CAPITAL STOCK Continued Accounts Continued Opening entry, 1067 Represents investment of stockholders, 1037 Allotment of, incorporation provisions, "73 Amount authorized, journal entry, 1067 As owned capital, 596 Assessments on, 1059 Authorized account, 1068, 1083 , Not used for no-par stock, 1119 Records, 1071 Balance sheet, entry, 1360 Basis of, 79 Basis of payment for, 84, 1 139 Bonus, 93, 1140, 1174 Account, 1140 Accounting treatment, 1179 Incorporation provisions, 1174 Books, 287-295 Forms, 1493-1497 Certificate book, 289 Closing of, 294 Inspection of, 292 Ledger, 291, 1071 Statutory rules, 292 Subscription ledger, 1080 Transfer book, 293 By-law provisions, 222-227 Forms, 1463, 1466 Charter provisions, 187 Special, 203 Classifications of, 85, 203, 489, 510 Collateral security, 307-309, 862 Conversion of bonds into, 1254 Debenture, 634 Debts paid in, 1136 Defined, 69, 79, 664 Discount account. Entries for, 1096, 1102 Not used for no-par stock, 1119 Dividends, 152, 424, 433, 435, 682, 905 (See also "Dividends") Accounting procedure, 1151 No-par value, accounting for, 1152 Donated, 1063, 1106 Accounting entries, 1106-1112, 1162, 1179 Effect of capitalization on sale of, 71 English methods, 597 Exchange of corporation's own for other, 1138 Exchanged for property. Action of directors, 282 Action of stockholders, 275 Proposal form, 1508 INDEX CAPITAL STOCK continued Face value, 80 Stated in charter, 187 Form of, 76 Founders' shares, 97, 599 Fractional share. By-laws, 227 Transfer of, 299, 338 Full-paid, 84, 99-103, 222 Accounting methods, 1065-1075 Transfer rights, 309, 314 Treasury stock as, 104 Guaranteed, 91 Holding companies, 204, 322, 473-482 Inter-company ownership, on consolidated balance sheet, 1376, 1380 Issued, 83, 104 Face value, 84 For other than cash, 1157, 1161 Issues, consolidations, 1287 Journal, Entries, 1065, 1084 Subscriptions, 1084 Ledger, 1071 Form, 1072 Reconciliation of, 1073 Summary of accounts used, 1083 Lien on, 310 Mines, 424 No-par value, 81, 111-130 (For complete index see "No-par Value Stock") Not full-paid at once. Accounting Methods, 1076, 1085 Option on. Form, 1512 Original issue, conditions of issue, 1065 Ownership evidence, 81, 287 Par and no-par value stock issued by same Par value, [company, 1120 Accounting methods, 1063-1112 Changed to no-par, 1122, 1309 Partnership incorporating, 499, 502-504 Premium account, 1097-1100, 1119 Not used for no-par stock, 1119 Price, Affected by dividend rate, 669 Affected by earning power, 666 Purchase and sale of, After organization, accounting entry, 1082 By one corporation from another, 109, 1136-1140 Commission on, 1134, 1174, n?9 Discount, 1006 Methods of payment, 1138 Premium on, 1097-1100 Restriction on, 513, 600 CAPITAL STOCK Continued Records, 287-295 Reduction of, 1059 In reorganization, 1308-1310 Rights. 136, 805-813 Conditions of subscription offer, 806 Parity value, 809 Parity value when quoted ex-rights, 813 Quoted at a discount and premium, 811 Selling ex-rights, 812 Trading in, 807 When issued basis, 807 Salaries paid in, 1135 Subscribed account, 1078, 1083 Subscriptions (See "Subscriptions") Subsidiary records, 1071 Instalment book, 1088-1095 No-par value, 1116 Reconciliation of, 1073, 1088 Unissued, 83 Not a treasury stock, 104, noi Unissued account, 1068, 1083 Not affected until certificates are issued. Not used for no-par stock, 1119 [1078 Records, 1071 Unpaid, Stockholders' liability, 144 Transfer rights, 309, 314 Valuation, subsidiary corporations, 1136 Voting-trust, 470, 472 Watered, 85, 99 CAPITAL STOCK TAX, 30, 330 CAPITALIZATION, Basis of, 70, 664 Appreciation of property, 664 Earning power, 73, 665, 667-673 Intangible assets, 665 Investment, 666 Bond issues, 76 Book value, 676 Defined, 69, 663 Effect of, on sale of shares, 71 Form ef, 76 Good-will, 74, 676-681 Initial expenses and losses, 683 Less than real value, 72 Partnership incorporating, 499 Speculative features, 74, 78 Surplus, 682 Valuation, 73, 676 CAR TRUST BONDS (See "Equipment Trust Bonds") CASH, Basis for fund, 1226 Borrowed for dividends, 900, 1146 Budget, 931, 933 Ratio of, to current liabilities, 954 1664 INDEX CASH BOOK, Entries, 1170 CASH PAYMENTS, Dividends, 431, 433, 899, 1144 CASH VALUE, Capitalization based on, 71, 79 CERTIFICATE OF INCORPORATION (See "Char- ter") CERTIFICATES, Forms, 1598-1605 Inspectors of elections, Form, 1556 Trustee's Bond, Form, 1623 CERTIFICATES OF STOCK, 81 Forms, 1485-1492 Adopted at first directors' meeting, 280 Assignment and transfer, 223, 296-301 Book, 289, 1071 In charge of secretary, 290 By-laws, 222 Cancellation, 290 Corporation acquiring stock of another, 323 Corporation selling stock to another, 322 Dollar- marked, 112 Face value, 112 Errors in issuing, 290 Fractional share, 227 Full-paid, 102 Held in name of executor, not taxable, 327 Indemnity bonds for lost, Form, 1617 Issuance, journal entry, 1087 Loss of, 226, 304 Negotiability of, 82, 306 New, 289, 298, 1074 No-par value, 127 Not a final evidence of ownership, 287 Not issued until subscription paid in full. Preferred, 88 [1076 Rights of owner, 223 Signature and sealing, 223, 316, 392 Stamps on, 328 Transfer agent's procedure, 303 Transfer form, 316 Transfer register entries, 1087 Treasury stock, 302 When not issued, 288 CHAIN STORES, Expansion plan, 940 CHARTER, 10 Forms, 1425-1462 Amendments, Difficulty overcome by including certain provisions in by-laws, 205 Procedure, 212 Stockholders' consent to, 132. 141 CHARTER Continued Application, 170, 208 Alterations, 211 Approval of, 209 Certified copies, 211 Filing of, 210 Signature and acknowledgment, 209 Business corporations, 168 Capital stock provisions, 79, 187 Common law, 167, 170 Common stock provisions, 188 Consolidation, 1286 Copy inserted in minute book, 370 Corporate stockholding, 204 Cumulative voting, 203 Delaware, Form, 1430-1441 Details of, 170 Directors, 192-198 Early, 199 Financial institutions, 169 General provisions, 199 Incorporators, 172-176 Life-term of corporation, 191 Limitation on indebtedness, 204 Limitation on salaries, 205 Minority stockholders, special provisions for, 491 Name, 172-176 Nature of, 165 New Jersey, Form, 1428-1430 New York, Form, 1425-1428 Not a franchise, 166 Place of business, 190 Precorporate provisions, 44 Preferred stock provisions, 87, 89, 90 Principal office location stated in, 190 Public utility corporations, 168 Purposes, 182-185 Salary limitations, 205 Special provisions, 197-207 Forms, 1442-1462 State laws must be followed, 166 Stock and non-stock, 167 Stock, classification of, 203 Stockholders' rights, special provisions, 139 Surrender of old, when forming consoli- dation, 1286 Voting provisions, 134 CHECKS, Corporate, Form, 1588-1592 Dividend, 438, 442, 1143 Indorsements, Forms, 1591 INDEX 1665 CHECKS Continued Signatures on. Forms, 1588-1392 CHICAGO AND ALTON RAILROAD COMPANY, Exploitation of, 987 CHICAGO, ROCK ISLAND AND PACIFIC RAIL- WAY COMPANY, Financial plan, 748 CLAFLIN, H. B. COMPANY, Reorganization. 1028 CLAIMS, Receiverships, Accounting, 1327 Settlement of, in insolvency, 999 CLOSE CORPORATIONS, 510-515, 584 By-laws, 219 Capital, sources of, 797 Capitalization of-, 72 Management, 511 Nature of, 510 Profits, apportionment of, 511 Restriction of stock, 513, 600 Stockholders, 513 CLOSING OF BOOKS, Annual, 1349 Corrections after, 1040 Ledger, 1351 Partnerships incorporated, 1180, 1182 Procedure, 1350 Profit and loss account, 1352 COLLATERAL SECURITY, Accounting entries, 1264 Accounts receivable, 864 Bank credit, 86 1 Bills of lading, 863 Lien's, 863 Merchandise, 863 Note for, Forms, 1595-1597 Return of, accounting entries, 1255 Stock as, procedure for, 307-309 Stocks and bonds, 862 Warehouse receipts, 863 COLLATERAL TRUST BONDS, 464, 631 Redemption, accounting entries, 1254 Sale, accounting entries, 1198 COLLECTIONS, Treasurer's liability for, 415 COLORADO FUEL AND IRON COMPANY, 587 COMBINATION RECORD, 1035 COMBINATIONS (See also "Affiliated and Subsidiary Corporations," "Consolida- tions," "Export Associations," "Holding Companies," "Trusts") Defined, 744 Field for, 739 Financial plan, 744-748; 936-946 Interlocking directorates, 580, 1268 COMBINATIONS Continued National Starch Manufacturing Company, 741-744 Organization, 519 Promoting, preliminary investigation of, 761 Successful, 750 Types of, 737 COMBINATIONS IN RESTRAINT OF TRADE, 519 Express trust as, 535 COMMISSION PAYMENTS, Accounting treatment, 1179 Sale of capital stock, 1134, 1174, 1179 Sale of securities, 825 Stock exchange brokers, 831 Underwriting syndicates, 844, 1174 COMMITTEES, By-law, report, Form, 1651 Executive, 246, 247, 249 Finance, 246 Relation to treasurer, 387 Scope and powers, 387 Reorganization, 1012-1015 Standing, Appointment of, 149, 197, 245, 247 By-laws, 245-251 Composition, 249 Has no delegation power, 251 Kinds of, 246 Powers, 249 Procedure, for meetings, 250, 367 Purpose, 245 Quorum for meetings, 251 Written records of meetings, 250, COMMON LAW, 5 By-law powers, 217 COMMON LAW COMPANIES (See "Express Trusts") COMMON STOCK Certificate, Form, 1486 Charter provisions, 1 88 Classification of, 203 Classes, 598 Defined, 85, 598 Dividends, 884 Intangible assets represented by, 726 Issues of financial plan, 723-728 Partnership incorporating, 503 Represents intangible assets, 87 Voting and non-voting classes, 203 COMPANY (Word) IN NAME, 499 COMPENSATION FOR PERSONAL SERVICES, DIRECTORS', 243 COMPTROLLER, Duties and functions, 389 1 666 INDEX COMPTROLLER Continued Relation to treasurer, 389 Report, Form, 1649 CONSENT MEETING, 355 CONSOLIDATED BALANCE SHEETS, Forms, 1390-1393, 1396-1397 Combined, 1388 Contents, 1375 Defined, 1373 Guaranties, contracts and leases on, 1376 Intercompany holdings of capital stock on, 1376, 1380 Intercompany obligations, 1375, 1377 Inventory adjustments, 1375, 1376, 1381, 1395 Minority interests, 1385, 1386 Preparation, 1376 Basis of, 1385 Surplus adjustment, 1380, 1381 Value of, 1173 When to use, 1384 Work sheet, 1377 CONSOLIDATED MORTGAGE BONDS, 626 CONSOLIDATED STATEMENTS, Income, 1395 Intercompany income and expense items, 1395 Sales, 1395 When to use, 1384 CONSOLIDATIONS (See also "Affiliated and Subsidiary Corporations," "Combina- tions"^ Accounting, 1278-1295 Assets and liabilities taken over, 1 288 Balance sheet of new corporation, 1275 Closing books of dissolving companies, 1294 Holding company, 1268-1277 Issuance of stock and bonds, 1287 Purchase of leaseholds, 1260-1267 Requirements, 1285 Retirement of outstanding bonds and mortgages, 1292 Sale of securities, 1292 Settlement of intercompany obligations, 1293 Statement of merging companies, 1281 Transfer of property, 1279, 1286, 1292 By. Holding company, 1268-1277 Lease of property, 518, 1259-1267 Merger, 1268, 1278-1295 Purchase, 1268, 1278-1295 Purchase of assets, 518, 1278 Purchase of controlling interest, 519, 1268 /CONSOLIDATIONS Continued By-laws, 219 Capital requirements, 936 Capitalization, 73 Cause of insolvency, 936 Charter, 1286 Consolidated surplus, 1063 Defined, 744 Directors' agreement, 1286 Failures due to, 936 Financial policies, 936-946 Forms, 516 Good-will, apportionment of, 1284 Principles of, 1278 Procedure, 516-522, 1280-1287 Statutory, 517 Stockholders' approval, 1286 Surrender of old charters, 1286 Terms of merger, 1283 CONSTRUCTION ACCOUNT, Interest charged to, 684, 1211 CONTINGENT PROFIT ON STOCK ACCOUNT, 1102, 1103 CONTRACTS, 3 Forms, 1610-1614 Directors' power to make, 147 Enforcement of, legal right of corporation, 16 Exploitation of, 972, 974 Intercompany, on consolidated balance sheet, 1376 Precorporate, 42-49 Enforcement of, 44 Failure to incorporate, 48 Options, 47 Promoters' contracts, 46, 785, 788 Trustees', 48 Subscription, 34 CONTRIBUTED SURPLUS (See "Surplus Paid in") CONVERTIBLE BONDS, 463, 641-645 Redemption, accounting entries, 1254 CORPORATE FORM, Administrative system, 18 Advantages of, 13-21, 585 Based on division of powers and duties, 18 Characteristics of, 13, 569, 573, 585 Disadvantages, 22-31, 586 Efficiency, 585 Entity of, 15, 574 Investment attraction, 19 Legislative requirements, 23 Management, 569 Permanence of, 16 Reports required of, 24, 30 Stock transfer system, 17 Taxation (See "Taxation of Corporations" 1 INDEX 1667 CORPORATE FUNDS ' (See "Endowment Funds," "Extinguishment Funds," "Funds," "Reserves," "Redemption Funds," "Retirement Fund," Sinking Funds," "Surplus," "Trust Fund") CORPORATE NAME, Adoption of, of foreign corporation not doing business in state, 179 Changing, 180 Exclusive use of, 178 Infringement of, 179 Partnership, incorporation of, 498 Right to, 178, 179 Selection of, 177. 498 Statutory restrictions, 178 CORPORATE PURPOSES, Charter, Form, 1425, 1435 Clearly stated in charter, 182 Comprehensive, 183 Illegal, 184 Single, 182 Ultra vires acts, 185 CORPORATE SECURITIES (See "Securities") CORPORATIONS (See also "Close Corpora- tions") Business corporations defined, 167 Characteristics- of , 9, 13 Compared with partnership, 5 Constitution of the United States does not Life of, 191 [grant citizenship to, 51 Management system definite, 18 Non-stock, 1128-1132 Not organized for profit, 1129 Powers, acts in excess of, 185 Signature, Forms, 1583-1597 Statistics, 583 Stock and non-stock, 167 Stock transfer to and by, 316, 322-324 Taxation (See "Taxation of Corporations") CORRECTIONS, After closing of books, 1040 COST OF INCORPORATION, 60-68 Table, 6 1 COUNSEL, CORPORATE, 256 COUNSEL FEES, 67 COUPON BONDS, 448, 452, 622 Form, 1621 Interest record, 1188 Records for, 1 1 86 COUPON REGISTER, 1189 CREDIT, 849, 852 Affecting working capital requirements, 708 Bank, 858-863 Trade, 855-858 Use of. 559 CREDITORS, Settlement of claims in insolvency, 999 CUMULATIVE VOTING (See "Voting") CUSTOMERS, As sources of capital, 803 CUTTING A MELON, 1148, 1228 DARTMOUTH COLLEGE CASE, 16 DATE OF ANNUAL MEETING, 228 DEBENTURE BONDS, Forms, 1624 Defined, 450, 634 English practice, 625, 634 Investment value, 635 Nature of, 635 Protective provisions, 635 DEBENTURE STOCK, English practice, 634 DEBTS (See also "Funded Debt") Paid in stock', 1136 DECLARATION OF TRUST (See "Deed of Trust") DEED OF TRUST, Forms, 1625-1632 After-acquired property clause, 615 Bonds issued under, 453-456, 615 Bond redemption provisions, 1227 Express trusts, 545-548 DEFAULT, Bonds, 998, 1257 DEFERRED CHARGES, Operating expenses, determination of, 872 DELAWARE CHARTER FORM, 1435-1441 DELEGATION OF POWER, Directors, 245, 249 Officers, 160, 258 Power of attorney. Forms, 1606-1610 Standing committees, 251 DEPLETION, Extinguishment fund, 1226 Reserves, 1054 DEPOSITARY, Corporate, delegated by directors, 283 DEPRECIATION, Assets, intangible, 876 Appreciated assets, 1060 Income tax return, 1412 Reserves, 874-877 DIRECTORS, n, 579 Agreement for consolidation, 1286 By-laws, 235-244 Forms, 1464, 1469 Citizenship, 193 Classification of, 196, 238 1 668 INDEX DIRECTORS Continued Cumulative voting, 202 Dealings with corporations, 155, 579 Efficiency, 586 Election, 132, 142, 154, 155, 232, 274,346 Notice, form, 1573 Exploitation by, 970-991 Holding over, 155 Interlocking, 580, 1268 Liability, 150, 204 Illegal dividends, 445 Limitations of, 195 Indebtedness, 204 Managing, 255 Meetings (See "Meetings, Directors") Number of, 193, 235 Partnerships, incorporating, 504 Powers, 195, 236, 578 Appointment of officers, 157 As trustees for stockholders, 148 By-laws, adoption of, 150, 195, 217, 218, 244 Common law, 151 Collective only, 147 Declaration of dividends, 420 Inspection of minutes, 369 Limitation of, 147, 261 Over surplus, 1047 Over treasurer, 385 Removal of officers and agents, 149, 162 Resolutions to supplement by-laws, 381 Standing committees, 149, 197, 245 Statutory law, 151 To delegate authority, 245 To fill vacancies in board, 154, 238 Qualifications, 192, 236 Relation to treasurer, 385 Removal, 153, 238 Residence, 192 Resignation, 152 Form, 1578 Salary or compensation, 243, 581 Stockholding provisions, 192, 236 Term of office, 196, 237 Treasurer's reports to, 412 Vacancies on board, 154, 238 Voting, no proxies allowed, 364 DISCOUNTS, Affecting working capital, 705 On bonds. Account, 1192 Accounting, 1213-1224 Capitalized, 684 On stock account, 1096 Credited to contingent profit on stock, IIO2 Not used for no-par stock, 1119 DISCOUNTS Continued Stock bought, 1 103 Stock rights quoted at, 811 DISCUSSIONS, Not entered in minute book, 372 DISSOLUTION, Accounting, 1297-1306, 1340 Accounts not closed, 1302 Profit or loss on realization, 1 298 Sale of business, 1299-1306 Transfer of assets, 1300 Case of the, Reading Company, 1002 United States Express Company, 1002 Closing books of dissolving companies, 1 294 Following bankruptcy, 1340 Insolvent corporation, 1001 Nature of, 523 Voluntary, 1001 Accounting, 1297-1306 DIVIDENDS, Accounting, 1142-1155 Charged to profit and loss or surplus, 1039 Accrued, 1142, 1271 Banks, accounting procedure, 1154 Bonds, 433, 435, 1153 Book , Forms, 1637 By-laws, 260, 420 Forms, 1465, 1472 Cash, 431, 433 Accounting procedure, 1144-1146 Cash requirements, 899 Cause of insolvency, 997 Checks, 438, 442 Accounting procedure, 1143 Classification, 884 Common, 884 Cumulative, 91 Accounting procedure, 1151 Cutting a melon, 1148, 1228 Debt of Corporation, 429 Declaration of, 420 Form, 1571 Accounting procedure, 1143 Compulsory, 426 Out of capital stock, 152, 424 Resolution, 422 Revocation, 430 Determination of profits, 425, 1039 Earnings, percentage of, devoted to, 886 Effect of capitalization on, 71 Equality, 425 Ford Motor Company case, 427 Form of payment, 431-433, 1143 Guaranties of, in lease, 1261. 1.264, 1265 INDEX 1669 DIVIDENDS Continued Illegal, 443-446 In payment of stock subscriptions, 430, Income from, 1 1 ss [1149 Interim, accounting procedure, 1148 Liability for, 445 New Jersey regulations, 420 No-par stock, 1146 Notice, 438 Forms, 1571 Other than cash, 433, 905 Ownership, record of, 1142 Paid out, By subsidiaries, 1381 By treasurer, 423 Of bonds or property, 433, 435, 1153 Of borrowed cash, 900, 1146 Of no-par stock, 1152 Of paid-in surplus, 1059 Of profits, 423, 883-897, 1153 Of surplus, 424, 899, 1047 Paid to pledgee of stock, 441 Passed, accounting procedure, 1151 Place of payment, 438 Preferred stock, 87, 90, 428, 602, 884 Cumulative, 91, 605 Non-cumulative, 92, 603, 884 Participation rights, 93, 606 Passed, accounting procedure, 1151 Rates, 606 Profits distributed as salaries, 431 Profits, proper source of, 423 Property, 433, 437 Rates, 885 Policy, as to, 913 Receipt for, 1144 F;rm, 1594 Regularity of, 888-897 Scrip, 436 Accounting procedure, 1147 Sheet or book, 1 144 Special, accounting procedure, 1148 Statistics, 885 Statutory law, 421 Stock, 433, 435, 682, 905 Accounting procedure, 1151 No-par value, accounting of, 1152 Stockholders' rights, 135 Time of payment, 438 To whom paid, 439 Treasury stock, 433, 441 Trust fund for paying, 429 Unearned, 902, 1154 Used as payment for subscriptions, 430 Voting trust, 470 Withholding surplus from, 1047 Wrong methods, 902 DOLLAR-MARKED STOCK CERTIFICATE, 112 DOMESTIC CORPORATIONS (Intra-State), Incorporation, 51 Taxation of stock without par value, 126 DONATIONS, Hospital accounts, 1130, 1131 Treasury stock. Accounting entries, 1106-1112, 1162, Donated stock account, 1 108 [i 179 No-par value, 1126 Surplus account, 1108 Surplus from, 1063 Forms, 1590, 1592 DUMMY INCORPORATORS, 173, 174, 175 DUMMY STOCKHOLDERS, Liability of, 316 EARNING POWER, Adjustment of capitalization to, 670 Affected by adverse legislation, 673 Affected by individuals, 673 Capitalization based on, 71, 73, 79, 665, 667-673 Estimates of, 671 Rate of, 669 EARNINGS, Gross, determination of, 869-872 Surplus form, 913 EFFECTIVE RATE METHOD, Bond discount and premium, 1218 ELECTIONS (See also "Votes") Ballot. Form, 1558 Can be set aside by injunction w en illeg- ally controlled, 348 Certificate of inspectors. Form, 1556 Certificates, Forms, 1601 Directors, 132, 142, 154, 155, 232, 274, 346, 507 Majority requirements, 507 Oath of inspectors. Form, 1556 Officers, 242, 279, 366 ELECTRIC RAILWAY, Promoting, preliminary investigation oi, 758 ELEEMOSYNARY INSTITUTIONS, Accounting, 1130-1132 EMPLOYEES, Stock participation, 802 ENDOWMENT FUNDS, Accounting, 1130, 1131 Nature of, 1225 1670 INDEX ENGINEERS, As promoters, 774 EQUAL INSTALMENT METHOD, Bond discount and premiums, 1219 EQUIPMENT TRUST BONDS, 465, 629-631 Redemption, accounting entries, 1255 Sale, accounting entries, 1200 ESTATE TAX (See "Inheritance Tax") ETHICS, Contractual, 973 EXCESS PROFITS TAX, 29, 332 Repeal of, 1399 EXCISE TAX (See "Capital Stock Tax") EXECUTIVE COMMITTEE, 246, 247, 249 EXECUTIVES, As promoters, 775 EXECUTORS, Stock transfer by, 315, 317, 319 When taxable, 328 Votes, 135 EXPANSION (See "Combinations," "Consoli- dations") EXPENDITURES, Concealment of, 880 Operating, 872-879 EXPENSE ACCOUNT, Sinking fund, 1230 EXPENSES, Calculation of, for budget, 933 Consolidated statement item, 1395 Deferred charges, determination of, 872 Income tax return, 1411 Initial, capitalization of, 684 Operating ratios, 956 Organization, 60-68, 1133, 1169 Receivership, 1348 Reorganization, 1013 Reserves for, 1050 Sale of bonds, 1213 Sale of securities, 828, 1174 Underwriting, 1174 KXPLOITATION, By directors, 979-991 By officers, 967-978 By stockholders, 979-991 Case of the, Baltimore and Ohio Railroad, 979 Chicago and Alton Railroad, 987 Interborough Rapid Transit Company, 988 Missouri Pacific Railway, 968 National Cordage Company, 977 National Salt Company, 9$s New Haven Railroad, 970, 984 Northern Pacific Railroad, 973 Rock Island Railroad, 972 Standard Rope and Twine Company, 97 2 EXPLOITATION Continued Case of the Continued United States Shipbuilding Company, 97i Contracts, 972 Creditors, 987 Exorbitant salaries, 971 Juggling accounts, 979 Misleading statements, 980 Misuse of information, 976, 982 Nature of, 967 Precautions against, 989 Squeezing minority stockholders, 985 EXPORT ASSOCIATIONS, 590 EXPRESS TRUSTS, Advantages, 540 As a combination in restraint of trade, 533 Creators of, 548 Deed of trusts, 545-548 Defined, 532 Liability of individuals under, 549 Misuse of, 538 Nature of, 533, 57 1 Provisions, 545 Status of, 539 Statutory laws, 541 Taxation, 542 Trustees, 533, 534, 548-551 Use of, in business, 536 Varied nomenclature for, 537 Who may create, 534 Ex-RlGHTS, Stock rights, 812 EXTINGUISHMENT FUNDS, Nature of, 1225 EXTRA-TERRITORIAL RIGHTS, Stock transfer tax, 328 FACTORY SITES, Donated, 1063 FAILURES (See "Insolvency") FEDERAL RESERVE BANK, Balance sheet, 1357-1360 FEDERAL TAXES, 29 FEES (See "Counsel Fees," "Organization Fees") FILING, Charter application, 210 FINANCE COMMITTEE (See "Committees, Finance") FINANCIAL CORPORATIONS, Charters, 169 FINANCIAL INSTITUTIONS, Capitalization of, 73 Source for capital funds, 792 INDEX 1671 FINANCIAL MANAGEMENT, Problems, 960-965 Standards, 947-959 FINANCIAL PLAN, Advertising agency, 734 American Woolen Company, 847 Combination, 744-748 Partnership incorporating, 730 Policies and methods, 720-730 Railroad, 732 Reorganization, 1010-1017 Rock Island Railroad, 748 Securities issued, 720-728 Underwriting syndicates, 837-848 United States Realty and Construction Company, 845 United States Shipbuilding Corporation, 846 FINANCIAL STATEMENTS (See also "Balance Sheet," "Consolidated Balance Sheet," "Consolidated Statements") Forms, 1355, 1643-1651 ' Corporate reports, 1354 Income statement, 867 Merging companies, 1281 Misleading, 980 Monthly, 1349 Receivers, 1313-1316, 1324 FINANCING, Adequate, 769 Budget plan, 561 Directed by finance committee, 387 Inadequate, 770 Individual vs. business, 558 Preliminary, 765 Relation to accounting, 557 Rules, 562 Standards, 947-965 Unskilful, 556 FINANCING CORPORATIONS, Working capital requirements, 716 FIXED ASSETS (See "Assets, Fixed") FIXED CAPITAL, Defined, 687 Requirements, estimating, 693 FIXED CHARGES, 883 Reducing, 1024 FLUCTUATIONS IN BUSINESS, Effect of budget on, 927 Effect of dividends on, 888-893 FORD MOTOR COMPANY, Compulsory dividends, 427 FOREIGN CORPORATIONS (other states), Doing business without authorization, 54 Incorporation, 51 Selection of state, 190 Inheritance taxes, 27 FOREIGN CORPORATIONS Continued Name may be adopted, 179 Reports, 31 Taxation of, 28 Taxation of stock, without par value, 126 FOREIGN CURRENCY, Bonds payable in, 620 FOREIGN TRADE, Working capital requirements, 708 FORMS (See also contents to Book IV, p. xii.) Consolidated balance sheet, 1390-1393, 1396-1397 Income Tax, 1401-1402, 1409-1410, 1410- FOUNDERS' SHARES, 97, 599 [1421 FRANCHISE TAX, 25, 60, 333 Comparative table o.f, 61 FUNDED DEBT, Short-term notes not, 652 FUNDS (See also "Endowment Funds," "Ex- tinguishment Funds," "Redemption Funds," "Reserves," "Retirement Funds," "Sinking Funds," "Surplus," "Trust Funds") Accounting, 1225-1246 Collections, 415 Compared to reserves, 1226 Custody of, 377, 417 Defined, 415 Disbursement, 418 How created, 1226 Misuse of, 977 Nature of, 1225 Purposes, 1225 Return of, 419 Treasurer's liability for, 416 GAIN OR Loss (See also "Profit and Loss Account") Sale of a business, 1299 Sale of assets, 1298 During receiverships, 1337 GIFTS (See "Donations") GOLD BONDS, 463, 621 GOOD-WILL, Accounting treatment, 1168 Apportionment, in consolidati6ns, 1284 Balance sheet entry, 1371 Capitalization of, 74, 676 Customers, 803 Employees, 802 Sole proprietorship, 1166 Stockholders', 800 Transfer of, 1167 Valuation, 678-681, 1166 Writing off, 1309 1672 INDEX GUARANTEED BONDS, 464 Interest, 1209 Redemption, accounting entries, 1255 Sale, accounting entries, 1197 GUARANTEED STOCK, 91 GUARANTIES OF INTEREST AND DIVIDENDS ON LEASEHOLDS, 1261, 1264, 1265, 1376 GUARDIAN OF MINOR FOR TRANSFER OF STOCK, 321 HOLDING COMPANIES (See also "Affiliated and Subsidiary Corporations," "Con- solidated Balance Sheets") Advantages, 473, 592 Amount necessary to control, 476 As minority stockholder of subsidiary, 1385, 1386 Common law did not permit, 474 Consolidated income ta:c returns, 1416 Consolidation by, Accounting, 1260-1277 Accrued dividends, 1271 Balance sheet, 1272 Income account, 1272 Interlocking directorates, 1268 Defined, 473, 1268 Development, 589 Functions, 478, 591 Harmful, taxation no remedy against, 22 Intercompany ownership of bonds on consolidated balance sheet, 1376 Intercompany ownership of stock on con- solidated balance sheet, 1376 Limitations, 479 Methods of control, 1268 New Jersey laws, 57, 475 Operating, purchase of subsidiary, 1273- 1277 Parent company, 481, 593, 1277 Public utilities use of, 592 Status of, 591 Stock holding powers, 474 Subsidiaries, 593, 1269 Valuation of stock of, 1136 HORIZONTAL TRUST OR COMBINE, 737 HOSPITALS Accounting, 1130-1132 IDAHO, Incorporation in, 58 ILLINOIS, By-law statutes, 219 Incorporation in, 57 IMPROVEMENTS, Amortization, 1265 Leaseholds, accounting, 1264 INCOME (See also "Gross Income," "Net Income") Administration, 867-882 Calculation of, for budget, 932 Denned, 868 From dividends, 1155 From investments, accounting entry, 1212 Policy as to, 913-918 Relation between, and security issues, 724 Sinking funds, 1237, 1240 INCOME ACCOUNT, Consolidated, 1395 Sinking funds, 1230 INCOME BONDS, 463, 638-641 Interest, 639, 1210 INCOME STATEMENT, 867-882 Analysis of, 867-882 Calculation, 868 Concealment of profits, 879 Depreciation, 873-877 Gross earnings, 869-872 Operating expenses and reductions, 872- 879 INCOME TAX, Effect of, 64, 501 Federal, 29, 33 1 Forms, 1401-1402, 1409-1410, 1410- 1421 Accounting practice, 1042-1045 Consolidated returns, 1416 Effect on accounting, 1042 Express trusts and, 543 Organization expense not deductible, H33 Preparation of returns, 1399-1421 State, 26, 333 INCORPORATED (Word) IN NAME, 178, 498 INCORPORATION (See also "Charter," "Organ- ization") Agreements, 44, 1172 Bond issues for property taken over, 63 Charter application, 208-211 Cheapness not always desirable, 55 Commission on sale of capital stock, 1134 Contracts prior to, 42-49 Cost of, 60-68 Counsel fees, 67 Domestic corporation, 51 Double, 6s Failure to incorporate, 48 Foreign corporation, S 1 Manufacturing corporation, accounting procedure, 1156-1160 Mining corporation, 1160 INDEX 1673 INCORPORATION Continued Minority interests, 58 Organization expenses, accounting, 1133 Organization fees, 60-66 Table, 61 Partnerships, 497-5O9 (For full list of subjects see "Partner- ships") Accounting treatment, 1172-1183 Place of, 50-59 Procedure, 267 Promoter's functions, 44 Sole proprietorship, 1165 State laws beneficial for, 56 State, selection for, 190 Stock sold at a premium to create surplus, 1098 Taxation and, 501 Taxes, 25 When inadvisable, 22 Who may incorporate, 172 I NCORPORATORS, Agreements among, 14 Dummy, 173, 174, 175 Functions of, 174 Number, 173, 268 Participation in first stockholders' meeting, 268, 272 Signature and acknowledgment of charter application, 209 Stockholders as, 174 Supply initial capital, 791 Who may incorporate, 172 INDEBTEDNESS, Liability of, 204 Limitation of, 261 INDEMNITY BOND, Forms, 1616-1618 INDIVIDUAL MANAGEMENT, 7 INDORSEMENTS, CORPORATE CHECKS, Forms, 1591 INFORMATION, Confidential, misuse of, 976, 982 INHERITANCE TAX, Federal, 30 Foreign corporations, 27 State, 27 INSOLVENCY, After dividend is declared, 429 Bankruptcy, 1003-1005 Causes of, 771, 995-098 Dissolution of corporation, 1001 Due to consolidations, 936 Economic, 993 Financial, 994 Procedure for, 998-1009 Readjustment of claims, 999 INSOLVENCY Continued Receiverships, 1005-1009 Statistics, 992 Types of, 936 INSTALMENT ACCOUNT, Bond issues, 1196 Purchaser of accounts receivable, 715 Subscription to stock, 222, 1077, 1090 Book for, 1088-1095 Form, 1635 Entries, 1091-1095 Notice of payment, Form, 1569 INSTALMENT BUSINESS, Working capital requirements, 709-713 INTERBOROUGH RAPID TRANSIT COMPANY, ^Exploitation of, 988 INTEREST, Accrued, 1193, 1195, 1204 Adjustment of, in selling price of bonds, 1213 Bonds, 622 Accounting, 1192, 1202-1212 Accrued, 1193, 1195, 1204 Adjustment of accrued interest in selling price, 1213 Charged to construction, 684, I2II Default in payment, 1257 Guaranteed bonds, 1209 Income bonds, 1210 Methods of handling coupons, 1202 Methods of paying, 1202 Recording, 1188, 1203 Registered bonds, 1205 Special issues, 1210 Treasury bonds, 1208 Two or more issues, 1206 Coupon bonds, record of, 1188 Guaranteed bonds, 1197 Guaranties of, in lease, 1261, 1264, 1265 Income bonds, 639 Income from investments, accounting entry, 1212 Income tax, 1406 Paid on bonds during period of construction may be capitalized, 684, 1211 Registered bonds, record, 1188 Sinking fund, accounting entries, 1237 INTERIM DIVIDENDS, 1148 INTERLOCKING DIRECTORATES, 580, 1268 INTERSTATE COMMERCE COMMISSION Regulations, Bond terminology, 1 1 86 Interest charged to construction, 1211 Sinking fund, 1231 INVENTORIES, Cause of insolvency, 997 1674 INDEX I NVENTORIES Continued Certificate of, on income tax return, 1408 Statistics, 958 Valuation, Consolidated balance sheet entries, 1375, 1376 Cost or market, 870 INVESTIGATIONS, Combination, 761 Electric railway, 758 New enterprises, 754-762 Preliminary analysis, 757 Railroad, 759 Scope of, 756 INVESTMENT BANKERS, Community of interests among, 1840 Liability of, 826 , Sale of securities, 823-829 Underwriting syndicates formed by, 833 INVESTMENTS (See also "Securities") Corporations an attractive form of, 19 Distribution of, as a safety factor, 795 Sinking fund, accounting entries, 1239 JOINT ADVENTURES, Nature of, 530 JOINT-STOCK COMPANIES, Accounts, nature of, 1033 Nature of, 9, 525-527, 570 JOURNAL, Entries, Manufacturing corporation, 1157 Mining corporation, 1161 Subscription to stock, 1068, 1076, 1084 Subscription transfer, 1088 KANSAS SUPREME COURT, Decision on stock without par value, 114 LAND COMPANIES, Sinking funds for bond redemption, 660 LAW, Business organization dependent on, 3 Contracts, 3 Incorporation, 51-58 Legal entity of corporation, 15 Partnerships, 4 Principal and agent, 4 Subscriptions, 33-41 LAWYERS, As promoters, 773 Counsel fees, 67 LEASEHOLDS, Accounting, 1260-1267 Adjusted entries at end of year, 1265 Guaranties of interest or dividends, 1261, 1264, 1265 Improvements and note issues, 1 264 Improvements on, 1265 Mines, 1263 Railroads, 1264 Amortization, 1265 Consolidations by, 1259-1267 Intercompany, on consolidated balance sheet, 1376 Terms of, 1261 LEDGER, Closing, 1351 Stock, 1071 Defined, 291 Summary of accounts used, 1083 Subscription, 1080, 1086 Instalment account, 1093 LEGISLATION, CORPORATE, ONEROUS RE- QUIREMENTS, 23 LESSEES, ACCOUNTING RECORDS, 1 267 LESSORS, ACCOUNTING RECORDS, 1266 LIABILITIES, Current, Ratio of, to current assets, 698 Short-term notes as, 652 Liquidation, receivership accounting, 1339 Transfer of in consolidation, 1286, 1289 LIABILITY OF CORPORATION, Before incorporation, 42-49 Doing business in California, 53 Limitation of, 14 LIABILITY OF DIRECTOR, 150 Limitations on indebtedness, 204 LIABILITY OF OFFICERS, 160 LIABILITY OF PARTNERS, 568 LIABILITY OF STOCKHOLDER, 14, 53, 143-148 Full-paid stock, 101 In California, 53 Statutory, 145 Unpaid outstanding stock, 145 Unpaid subscriptions, 143 Watered stock, 100 LIABILITY OF TREASURER, 393-400, 416 LIEN BONDS, JUNIOR, 462, 625 LIEN STOCK, 310 LIENS AS COLLATERAL SECURITY, 863 LIFE TERM OF CORPORATION, 191 LIQUIDATIONS, Preferred assets, 91 Realization and liquidation statement of receiver, 1346 Stockholders' rights in, 137. 142 INDEX 16/5 LOANS (See also "Notes"; "Bonds") Bank, 858-866 Factors considered, 864 Collateral for, 861 Long-term obligations, 854 Note-brokers' dealings, 859 Overborrowing risks, 852 Rules for borrowing, 853 Securing, 851 Short-term, Forms of, 854-866 Stock as collateral, 307-309 Trade acceptance, 856 Trade credit, 855-858 LOCATION (See "Place of Business") LONG TERM OBLIGATIONS (See also "Bonds") Nature of, 612, 632, 854 Received by creditors, 1023 Sinking fund methods, 658 LOSSES (See also "Gain or Loss") Caused by treasurer's neglect, 395 Extraordinary, debited to surplus, 1041 Initial, Capitalization of, 684 M MAIL, Selling securities by, 815 MAINE, INCORPORATION IN, 57 MAINTENANCE, Charged against income, 872 MANAGEMENT (See "Administration") MANAGER, By-laws, Forms, 1472 MANAGING DIRECTOR, BY-LAWS, 255 MANUFACTURING CORPORATION, Books of account, 1157 Incorporation, 1156 Journal entries, 1157 MARKET PRICE, Bonds purchased for sinking funds, 1221 MASSACHUSETTS, Express trusts, 541, 571 Incorporation in, 57 Stock transfer tax, 327 MEETINGS (See also "Minutes") Motions, 372 Paper used at, should be filed, 373 Protests, 373 Resolutions, 372 MEETINGS, COMMITTEES, PROCEDURE, 250,367 MEETINGS, DIRECTORS, 239-242, 358-368 Forms, 1504-1511, 1525-1527, I533-I534 Adjournment, 367 Annual, Omitted td hold over directors, 155 MEETINGS, DIRECTORS Continued Approval of minutes, 374 Assemblying, 360 Business, 366 Directors must be present in person, 364 Election of Officers, 242 First, 277-285 Forms, 1504-1511 Assemblying, 279 Business, 278, 285 By-Laws, 277 Call, 277 Call and waiver of notice, form, 1507 Corporate depositary delegated by, 283 Election of officers, 279 Exchange of stock for property, 282 Minutes, 278 Minutes, forms, 1504-1507 Opening, 279 ' Roll call, 279 Seal of corporation, 281 Stock certificates adopted, 280 Subscriptions accepted, 281 Treasurer's bond depositary, 283 Minutes, 365 Forms, 1563-1567 Motions, Forms, 1 543-1 545' Notice, 240, 360 Proof of, 364 Object and purpose, 359 Opening, 363 Order of business, 244 Place of, 190, 239, 358 Presiding officer, 363 Quorum, 241, 363, 364 Reports, 365 Resolutions, Forms, 1547-1552 Roll-call, 363 Special, 240, 360 Forms, 1525-1527. 1533 Call, 360 Call and waiver of notice, 363 Minutes, form, 1565 Notice, 361 MEETINGS, STOCKHOLDERS, 132, 576 Forms, 1498-1503. 1519-1525. 1529-1532 Adjourned, Minutes, form, 1561 Annual, 228-234; 335-351 Forms, 1531-1532 Adjournment of, 350 Annual report, 345 By-laws, 228-234 Closing transfer books, 336 Date of, 228, 336 1676 INDEX MEETINGS, STOCKHOLDERS Continued Annual Continued Election of directors, 232, 274, 346 Election inspectors' oath, form, 1356 List of stockholders, 338 Minutes, 339, 344- 351 Minutes, form, 1555. 1559 Notice, 336, 344 Object stated in notice, 336 Opening, 340 Order of business, 338 Place, 335 Preparations for, 338 Presiding officers, 339 Quorum, 341, 343 Roll-call, 340 Secretary of, 338 Time, 228 Unfinished business, 349 Voting, 342, 347-349 Approval of minutes, 374 By-laws, Forms, 1467 Elections, Forms, I5S5-ISS8 First, 267-276 Forms, 1498-1503 Assemblying, 268 By-laws adopted, 273 Call and waiver of notice, 268 Form, 1501, 1519 Charter presentation, 272 Conducting, 270 Election of directors, 274 Evidence of legality, 272 Exchange of stock for property, 275 Incorporators call, 268 Inspectors of election report, form, 1503 Minutes, forms, 1498-1501 Minutes, preparation of, 268 Opening, 272 Order of, 267 Participants, 268 Place, 269 Proxy, form, 1502 Time of, 269 List of stockholders, 231 Motions, Forms, I543-IS4S Notice of, 133, 230, 268 Order of business, 234 Place of, 190, 228 Presiding officers for, 230 Procedure and business, 229 Proxies, 135, 234 Quorum, 233 MEETINGS, STOCKHOLDERS Continued Resolutions, Form, 1546 Special, 229, 352-357 Forms, 1520-1525, I529-IS3I Adjournment, 357 Business, 356 Business of, must be specified in notice 353 Call, 352 Consent meeting, 355 Minutes, form, 1561 Notice, 354 Opening, 356 Statutory provisions, 352 Time of, 228 Voting, 231 MERGER (See "Consolidation") MINES, Dividends declared out of capital stock, 424 Leaseholds, accounting entries, 1263 Sinking funds for bond redemption, 660 MINING CORPORATION, Accounting procedure, 1161-1164 Incorporation, 1160 MINNESOTA, INCORPORATION IN, 58 MINORITY STOCKHOLDERS, Common law rights, 483 Holding company as, consolidated balance sheet items, 1385, 1386 Illegal methods of majority, 493 Protection of, 483-496, 577 Annual audits, 491 Cumulative voting, 202, 487 Legal remedies, 493 Special charter provisions, 491, 492 State laws, 58 Stock classification, 487 Voting trusts, 490 Representation on standing committees, 248 Rights, abridgement of, 484, 577 Squeezing, 985 MINORS, Stock transfer by, 315, 320 MINUTES, Forms, 1559-1567 Amendments, 374 Annual meeting, 339. 344i 351 Approval, 374 Book, 369-374 Alterations in, 370 Contents, 370 Format, 370 Motions and resolutions, 372 Proceedings, 37 Protests not usually included. ^75 INDEX 1677 MINUTES Continued Book Continued Secretary in charge of, 369 Signed by secretary, 351, 374 Writing of, 371 Certificate of transcript, Form, 1603 Correction, 375 Directors' first meeting, 278 Forms, 1504-1507 Directors' meetings, 365, 374 First stockholders' meeting, 269 Motions, Forms, 1543-1545 Prepared, 375 President's and secretary's certificate to, Form, 1603 Resolution, Forms, 1546-1552 Secretary's affidavit to. Form, 1604 Signing of, 3 Si, 374 Stockholders' annual meeting, Form, 1555 Stockholders' first meeting. Forms, 1498-1501 MISMANAGEMENT (See "Exploitation") MISSOURI PACIFIC RAILWAY, Exploitation of, 968 MONOPOLIES (See "Combinations in Restraint of Trade," "Trusts") MORTGAGE BONDS, After-acquired property clause, 615 Closed or open issues, 617 Consolidated, 626 Deeds of trust, 615 Defined, 451, 625 First mortgage, 462 Junior lien, 625 Limited open end, 617 Nature of, 614 Popularity, 625 Ratio of mortgage to property value, 627 Second mortgages, 625 MORTGAGES, Farm, 613 Loans, 612 Retirement in consolidation, 1292 MOTIONS, Forms, I543-IS4S Entered in minute books, 372 NAME (See "Corporate Name") NATIONAL CORDAGE COMPANY, Exploitation of, 977 NATIONAL SALT COMPANY Exploitation of, 985 NATIONAL STARCH MANUFACTURING COM- PANY, Financial plan, 741-744 NET INCOME, Determination of, 867-882 Distribution, 883-897 NET WORTH ACCOUNTS (See also "Capital Stock," "Reserves," "Surplus") Nature of, f 036 NEVADA, INCORPORATION IN, 57 NEW JERSEY, By-law statutes, 218 Charter form, 1428-1430 Dividend regulations, 421 History of legislation in, 197 Holding company law, 475 Incorporation in, 57 Preferred stock requirements, 90 Special charter provisions, 201 NEW YORK, NEW HAVEN AND HARTFORD RAILROAD, Exploitation of, 968, 984 NEW YORK STATE, Burdens imposed on corporations in, 52 By-law statutes, 218 Capital stock paid, 80 Charter form, 1425-1428 Directors' liability in, 150 Incorporation in, 57 Stock transfer rules, 325 Stock transfer tax, 327 NO-PAR VALUE (See also "Par Value") NO-PAR-VALUE STOCK, 81, 111-130 Accounting, 129, 1113-1127 Entered at sale price, 1113 Entries for, 1115 Nominal or stated value, 1113 Subsidiary records, 1116 Advantages, 120-123, 1141 And par-value issued by same corporation, II2O Authorization of shares, 124 Balance sheet entry, 1361 Bonuses paid in, 1141 Certificates, 127 Change in amount of authorization, 1125 Changed from par to no-par, 1122 Charter form, 1435-1441 Debts paid in, 1136 Disadvantages, 123 Dividends, 1146 Donated stock, 1126 Earned surplus of corporations having, 1117 Federal transfer tax, 329 1678 INDEX NO-PAR- VALUE STOCK Continued History of, 112 Judicial indorsement, 114 Laws concerning, 115 Organization fees, 126 Partnerships incorporating, 500 Preferred stock, 126, 1119 Takes precedence over, 1 26 Procedure, 124-130 Purchased by another corporation, 1139 Rights of holders, 126 , Selling price, 126 Stabilizer for capitalization, Status of, 113 Stock dividends, 1152 Taxation, 128 Theory of, in Treasury stock, 1125 Valuation, 130, 1114 Inflation of, 1121 When used, 117 NON-STOCK CORPORATIONS, Accounting, 1128-1132 Donations to, 1130, 1131 Hospitals, accounting, 1130-1132 Nation of, 1128 Trust funds, 1130 NORTHERN PACIFIC RAILROAD COMPANY, 587 Exploitation of, 973 NOTE-BROKERS, WORK OF, 647, 859 NOTES, Compared to bonds, 447 Corporate, Forms, 1 595-1 597 Short term, 465, 632, 647-652 (For com- plete list of subjects see "Short-Term Obligations") NOTICE, Appointments, Forms, 1573-1575 Directors' meetings, 240, 360, 361 Proof of, 364 Dividends, 43? Forms, IS7I-I573 Stockholders' annual meeting, 133, 230, 336 Proof of, 344 Stockholders' first meeting, 268, 272 Stockholders' special meeting, 354 OFFICE OF CORPORATION, PRINCIPAL, 190, 335 OFFICERS, 12 (See also under individual titles) Appointment of , 154. !S7 Assistant, 257 Auditor, 257 OFF.ICERS Continued By-laws, 252-259 Forms, 1465, 1471 Combined positions, 157 Counsel, 256 , De facto, 161 Defined, 157, 252 Delegation of authority, 160, 258 Duties, transfer of stock, 313 Election of, 242, 279, 366 Exploitation by, 967-978 Governed by law of agency, 159 Holding over term, 158 Liability, 160 When fraudulent transfer of stock is made by executor, 319 Managing, 255 Newly elected, assume duties at once, 366 On standing committees, 247 Partnership incorporating, 508 Penalties for misdeeds, 161 Powers, 159 Presiding, 230, 253 Directors' meetings, 363 Stockholders' meeting, 339 Qualifications of, 158 Removal of, 149, 162, 243, 159 Resignations, 163, 1581 Salaries, 258 Signature, Form, 1583 Stock transfer by, 300 Term of office, 158 Vacancies, 259 OKLAHOMA, EXPRESS TRUSTS, 542 OPENING ENTRIES, Incorporation of partnership, 1176 Incorporation of sole proprietorship, 1168 Manufacturing corporation, 1158 Mining corporation, 1161 OPERATING EXPENSES, 872-879 Ratio, 956 . OPTIONS, Assignment, Form, 1516 On business and property. Form, 1514 On capital stock, Form, 1512 On real estate, Form, 1515 Precorporate contracts, 47 ORDER OF BUSINESS, Directors' meeting, 244 Stockholders' meetings, 234 Annual, 338 INDEX 1679 ORGANIZATION (See also "Business Organiza- tion," "Incorporation," "Law") Economic necessity for, 7 Expenses, 60-68, 1133 Bonus account as, 1140 Not deductible from income tax, 1133 Reimbursed, 1169 Fees, 25, 60-66 Avoidance of, 64-66 Excessive, 64 Stock of no-par value, 126 Individual management, 7 Joint-stock companies, 9 Partnership, 8 Purpose of, 13 OVERCAPITALIZATION, 674 Defined, 663 OWNERS (See "Directors," "Officers " "Stockholders") PARLIAMENTARY PROCEDURE (See "Meet- ings," "Minutes") PARTICIPATING BONDS, 645 PARTICIPATION (See "Capital Stock"; "Divi- dends"; "Stockholder") PARTNERSHIP ASSOCIATIONS, Nature of, 528-330 PARTNERSHIPS, Accounts, compared to corporate, 1036 Advantages, 567 Compared to corporation, 4 Disadvantages, 568 Incorporation, 497-509 Accounting treatment, 1172-1183 Agreement of incorporation, 1173 Balance sheet audit, 1175 Balance sheet of new corporation, 1183 Capitalization, 499 Closing books, 1180, 1182 Directors, 504 Distribution of proceeds, 1181 Exchange of property for stock, 502 Financial plan, 730 Maintenance agreements, 506-509 Name, 498 Officer, 508 Preferred stock, 602 Stock issues, 87 Stock ownership, 409, 502-504 Taxation before and after, 501 Underwriting expenses, 1174 Valuation, 500 Voting requirements, 507 Voting trust agreements, 506 Stock classification, 510 PARTNERSHIPS Continued Joint adventures, 530 Legal actions against, 15 Liability of partners, 15 Limited, nature of, 570 Names, 177 Nature of, 8, 566-569 No definite system of management, 18 Stock transfer to and by, 324 PAR VALUE (See also "Discount"; "No-Par Value"; "Premium Account") Market for stocks sold below, 668 Stock of original issue, accounting methods, 1063-1112 Stock, reduction of, in reorganization, 1059, 1308 Stock rights, 809, 813 PATENTS, ASSIGNMENT OF, Form, 1614 PENALTIES, Enforcement of by-laws, 263 Stock transfer tax, 327 PENNSYLVANIA, Incorporation in, 57 Stock transfer tax, 327 PLACE OF BUSINESS, 50-59 Principal office, 190 Property tax for, 64 Stated in charter, 189 PLACE OF MEETING, Directors', 190, 239, 358 Stockholders, 190, 228, 335 PLEDGE (See "Collateral Security") POWER AND DUTIES (See "By-Laws" and Specific Headings, as "Directors"; "Secretary"; "Treasurer"; etc.) POWER OF ATTORNEY, Forms, 1606-1610 PRECORPORATE CONTRACTS (See "Contracts") PREFERRED STOCK, Accounting, journal entry, 1068 By-laws, 225 Certificate for, 88 Form, 1488 Charter provisions, 189 Classification of, 203 Form for, 90 Common stock bonus, 93 Compared with bonds, 88 Convertibility, 97, 602 Defined, 85, 601 Dividends, 87, 90, 92, 428, 602, 884 Cumulative, 91, 605 Non-Cumulative, 92, 603, 884 Participation rights, 93, 606 Rates, 606 Founders' shares, 97 i68o INDEX PREFERRED STOCK Continued Ledger, 1071 Nature and use, 87 New Jersey requirements, 90 No-par value, 126, 1119 Non-cumulative, 92 Partnerships incorporating, 500-503 Preference, As to assets, 91, 607 As to dividends, 90, 136, 601 Over no-par-value stock, 126 Protective features, 610 Redemption, 94, 607 Represents tangible assets, 87 Restrictions, 60 1 Rights carried by, 87, 601 Stockholder's assent for issue of, required, 88 Use of, 60 1 Voting rights, 88, 90, 95, 60 1, 602, 608 PREMIUM ACCOUNT, Bonds, 1191, 1213-1224 Capital stock, Credited with payments forfeited on subscription, 1081 Not used for no-par stock, 1119 Treatment, 1099 Uses of, 1098 PREMIUM, STOCK PURCHASED AT, 1104 PRESIDENT, 12 Annual report, Form, 1643 By-laws, Forms, 1471 Certificate of minutes, Form, 1603 Member of executive committee, 248 Presiding officer, 230, 253 Relation to treasurer, 391 Resignation, Form, 1581 Signature on certificates of stock, 392 PRINCIPAL AND AGENT, 4 PROBLEMS, Analysis based on financial standards, 960-965 PROFIT (See also "Gain or Loss") Adjustment of items of previous years, 1040 Apportionment of, in close corporation, 511 Charges against, 871, 872, 873 Closed into profit and loss account, 1040 Concealment of, 879 Credited to surplus account, 1038, 1039 Dividends paid out of, 423, 425, 886 During work of construction, 871 Extraordinary, credited to surplus, 1041 PROFIT Continued Fluctuations affecting dividend rates, 890 Percentage, 957 Promoter's, 780-790 Salaries paid out of dividends, 431 Source of capital, 792 Undivided, Account, 1058 Distinguished from surplus, 1047 Unrealized, on purchase of treasury stock, 1102 PROFIT AND Loss ACCOUNT, Closing, 1352 Function, 1042 Income tax charged against, 1044 Proof, 1043 Receiver's, 1328 Sale of capital assets, 1136 Surplus entered on, 1040 PROFIT-SHARING, 1148 PROMOTERS, 772-790 Donated stock from, 1107 Illegal arrangements, 786 Difficulties of, 778 Improper profits vs. over-valuation, 788 Precorporate contracts, 46, 777, 785 Profits, 780-790 Secret, 786-788 Property owned by, 789 Self-protection of, 777 Types of, 773-776 Work of, 44, 784 PROMOTION, Adequate finances, 769 Assembling the proposition, 762 Bank connections, 765 Co-operative, 767 Difficulties in, 778 Failures in, 771 Financing of construction work, 766 Investigation of enterprise, 754-762 Preliminary financing, 765 Requirements, 776 Steps in, 753, PROPERTY, Appreciation, basis of capitalization, 664 Dividends, 433, 437 PROPERTY TAX, 26, 64, 333 PROPRIETORSHIP, SOLE, Good-will, 1166 Incorporation, 1165-1171 Nature of, 564 PROSPECTUS, SALE OF SECURITIES, 818-820 F ROXY, Forms, 1 535-1 542 Directors may not vote by, 364 Stockholders' annual meeting, 341 INDEX 1681 PROXY Continued Stockholders' first meeting, 268 Form, 1502 Voting by, 135, 234. 342 PUBLIC, THE, Investing as a source of capital, 795 Speculative, as a source of capital, 795 PUBLIC UTILITIES, CAPITALIZATION OF, 73 PUBLIC UTILITY CORPORATIONS, Charters, 168 Holding companies for, 592 PUBLICITY, Among stockholders to cultivate good-will, 800 PURCHASE, Terms of, affecting working capital, 70S PURCHASE MONEY BONDS, 465 PURPOSES OF CORPORATION (See "Corporate Purposes") QUORUM, Committee meetings, 251 Directors' meetings, 241, 363, 364 Stockholders' meeting, 233 Annual, 341, 343 RAILROADS, Equipment trust bonds, 465, 629-631 Financing plan, 732 Leaseholds, accounting for, 1264 Promoting, preliminary investigation of, 759 Sinking funds, 1231 READING COMPANY, DISSOLUTION OF, 1002 REALIZATION AND LIQUIDATION STATEMENT, 1346 REALIZATION, GAIN OR Loss ON, 1298, 1299, 1338 RECEIPTS, CORPORATE, Forms, 1593-1595 RECEIVERS, Accounts, 1312-1329 Duties, 1006 Powers, 1007 Profit and loss, 1328, 1337 Reports, 1342-1348 Statement of affairs, 1313-1316, 1324 Statement on withdrawal, 1316 Statement to court; 1322 RECEIVERSHIPS, Accounting, Adjustment of asset values, 1326, 1333 Adjustment of company's books, 1325 RECEIVERSHIPS Continued Accounting Continued Cash account, 1345 Claims approved, entry of, 1327 Closing entries, 1321, 1329, 1339* 1341 Company accounts, 1313 Deficiency statement, 1343 Dissolution following, 1340 Exhibits and schedules, 1325 Expenses, 1348 Liquidation of liabilities, 1338 Loss and gain on realization, 1337 Opening entries, 1316, 1333 Procedure, 1317 Realization and liquidation statement, 1346^ Receiver's profit and loss, 1328, 1337 Reports, 342-1348 Sale of assets, 1331-1348 Statement to court, 1322, 1342-1348 Transactions, 1319, 1334 Application for, 1006 Dissolution following bankruptcy, 1340 Friendly, 1005 Nature of, 1005 Procedure, 1005-1009 State of affairs, 1313-1316, 1324. I33I.I335 RECORDS (See "Books of Account") REDEMPTION FUND (Seealso"SinkingFund") Compared to sinking funds, 1228 Nature of, 1225 Requirement, 1227 REFUNDING BONDS, 1252 REGISTERED BONDS, 448, 622 Interest record, 1188, 1205 Records for, 1 1 86 Transfer record, 1187 REGISTRAR (See "Transfer Agent and Regis- REGULATIONS, CORPORATE, [trar") How provided for, 215 REMOVAL FROM OFFICE, Agent, 149 Directors, 153, 238 Officers, 149, 162, 243, 259 RENEWALS, CHARGED AGAINST PROFIT, 872 REORGANIZATION, Accounting, reduction of stock, 1309 Advantages, 1026-1030 Agreement, 1307 Claflin company, 1028 Committees, 1012-1015 Defined, 1010, 1307 Expenses, 1013 Good-will, writing off, 1309 Interests concerned, ion Methods, 1307 Reduction of stock, 1308-1311 i682 INDEX REORGANIZATION Continued . Nature of, 522 Procedure, 1015-1017 Purposes, 1018 Raising additional capital, 1019-1023 Receivership, 1313-1348 (For full list of subjects see "Receiverships") Reducing capital stock, 1059, 1309 Reducing fixed charges, 1024 Status after, 1310 Underwriting syndicate, 1023 REPAIRS, CHARGED AGAINST PROFITS, 872 REPORTS, Forms, 1643-1651 Annual, 31 Reading of, at annual meeting, 345 Corporate, 1354 Officers and committees, 365 Foreign corporations, 31 Inserted in minute book, 372 Required, 24, 30 Tax, 30 Treasurer, 412-414 RESERVES (See also "Surplus") Accounting, entries for appropriation of surplus, 1048 Actual vs. book, 1055 Balance sheet entry, 1368 By-laws, 260 Forms, 1472 Charged against profits, 873 Compared to funds, 1226 Deed of trust provisions, 1227 Depletion, 1054 Depreciation, 874, 877 Expenses, 1050 General, 877-879 Hospital accounts, 1131 How created, 1226 Impounding of surplus, 1047, 1051 Nature of, 873 Non-operating, 1050 Accounting, 1052 Operating, Accounting, 1050 Permanency, 1048, 1051 Secret, 1052. 1056 Sinking fund, accounting entries, 1242 RESIGNATIONS, Forms, 1578-1581 Directors, 152 Officers, 163 RESOLUTIONS, Forms, 1546-1552 Certificate of. Forms, 1600-1601 RESOLUTIONS Continued Declaring dividends, 422 Entered in minute book, 372 RESTRAINT OF TRADE, COMBINATION IN 519 Express trust as, 535 RETIREMENT FUND, Cannot be termed a sinking fund, 1229 REVALUATION, 911 ROCK ISLAND RAILROAD COMPANY Exploitation of, 972 Financial plan, 748 ROLL-CALL, Directors' meetings, 363 First, 279 Stockholders' annual meeting, 340 Stockholders' first meeting, 268 SALARIES, By-law provisions, 206, 258 Charter provisions, 205 Directors, 243 Exorbitant, 971 Officers, 258 Paid from profits to avoid dividends, 43 1 Paid in stock, 1135 SALE OF A BUSINESS, Accounting, 1299 SALES, Bonds, Accounting for, 1194-1201 Discount and premium, 1213-1223 Consolidated statement items, 1395 Cost of, in income tax return, 1407 Estimates for budget, 926 Terms of, affecting working capital 708 SCRIP, DIVIDEND, 436 Accounting procedure, 1147 SEAL, Corporate, 263, 281 By-laws form, 1466, 1473 SEASONAL TRADES, Working capital requirements, 7 ;? SECRETARY, 12 Affidavit to minutes. Form, 1605 By-laws, Forms, 1471 Certificate of Minutes, Form, 1603 Duties, By-laws specify, 254 Preparation for annual meeting, 338 Record of minutes, 369 Sends notice of annual meeting, 337 Signing of minutes, 351, 374 Stock certificate book in charge of, 290 INDEX 1683 SECRETARY Continued Not a presiding officer, 230 Oath, Form, 1508 Of committees, 248 Relation to treasurer, 391 Stockholders' annual meetings, 339 SECURITIES (See also "Investments"; and special forms as "Bonds," "Capital Stock," etc.) Forms, 727 As collateral, 307-309, 682 Dealers in, 823 High grade, investors of, 792 Investigation of issue before selling, 824 Issues, Market conditions affecting, 720 Relation between and assets, 725 Relation between and income, 724 Salability, 720 Sale of, Accounting in consolidation, 1292 Advertising, 824 Buyers of speculative securities, 795 Circularizing lists, 816 Commission payments, 825 Dealers in, 823 Direct methods, 799-822 Expenses incurred, 828 Handling an issue, 824 Indirect methods, 823-836 Liability of dealer in, 826 Limitation on sale through dealer, 828 Mail order methods, 815 Market for, 796, 834 Personal methods, 816 Pre-sale investigation, 824 Prospectus, 818-820 Small-scale, 797 Stock exchange methods, 829-836 Surplus from, 910 To customers, 803 To employees, 802 To raise additional capital, 1019 To stockholders, 799 Underwriting method, 837-848 Surplus invested in, 1045 SERIAL BONDS, 656, 658 Redemption, accounting entries, 1253 Sale, accounting entries, 1200 SHAREHOLDER (See "Stockholder") SHARES (See "Capital Stock") SHORT-TERM OBLIGATIONS, Accounting entries, 1264 Banker's note, 647 Denned, 647 [652 Included as funded debt not good practice, SHORT-TKRM OBLIGATIONS Continued Investment value, 649 Nature of, 465, 632, 647, 854-866 Purpose of, 648 Redemption, accounting entries, 1255 Sale, accounting entries, 1199 Security for, 652 Sinking fund methods, 658 Use of, 649 Yield, 651 SIDE LINES, Capital invested in, 942-946 SIGNATURES, Forms, 1583-1597 Call and waiver of notice, 269, 277 Charter application, 208 Corporate, Certificates of stock, 223, 316, 392 Stock transfer assignment, 323 On checks, form, 1588-1592 Married woman, 317 Partners, stock transfer assignment, 324 President's, on certificates of stock, 392 Secretary's, on minutes, 351 Stockholder's, 300 Stockholder's receipt for dividend, 1144 Treasurer's, on certificates of stock, 392 SINKING FUND, Account, 1229 Accounting entries, 1236-1246 Adequacy of, 1232, 1249 Balance sheet entry, 1370 . Bond redemption, 457, 653-662, 1247-1250 Calculation, 1233 Defined, 456, 1228 Expense account, 1230 Income account, 1230 Income from, accounting entries, 1237 Interest on, accounting entries, 1237 Interstate Commerce Commission's regu- lations, 1231 Investments, Accounting entries, 1239 In company's own bonds, 1241 Income from accounting entries, 1240 Methods, 656-662 Annual purchase, of bonds, 658 Annuity, 1233-1235 Bond redemption, 657, 658, 659 Investment, 657 Land, lumber and mining companies, 660 Short-term notes, 658 Special, 660 Trustees, 657 Payments into, Accounting entry, 1237 Principles, 1231 1 684 INDEX SINKING FUND Continued Reserves, accounting entries, 1242 Stock redemption, 609 Trustee, 1236 Accounts of, 1245 SMALL CORPORATIONS (See "Close Corpora- tions") SPECIAL DIVIDENDS, 1148 SPECULATION, Stock Exchange dealings, 832 STAMPS, Stock transfer tax, 328 STANDARD ROPE AND TWINE COMPANY Exploitation of, 972 STANDARDS, Financial, 947-965 STANDING COMMITTEES (See "Committees") STATE RIGHTS, Corporations, 51 STATEMENT OF AFFAIRS, Receivers,' 1313-1316, 1324, 1331, 1335 STATES OF THE U. S., Incorporation laws, 51 Reputation of various, for incorporation, 56 STATUTORY LAW, 6 STOCK (See "Capital Stock," "Certificates of Stock," "Common Stock," "Dividends," "Preferred Stock," "Retirement Funds," "Stock Transfer," "Treasury Stock" STOCK COMPANIES, Joint, S2S-S27, 570 STOCK EXCHANGE, Methods, 829-836 STOCK TRANSFER, Accounting, 1074 Assignment of stock, Form, 316, 1509 Book, 293 By-law provisions, 225 Closing of, 288, 294, 336, 442 Kept by corporation, 302 By-laws, 224 Can be stopped when made to control an election, 348 Corporate responsibility for, 312, 319 Corporations purchasing own stock, con- ditions for, 322 Doubtful transactions, 312 Duties of officers, 300, 313 Evidenced in books, 287, 298 Fractional share, 299 Fraudulent, 319 Liability for, 314 Lien on stockholders for unpaid debts, 310 Old certificate surrendered before new is issued, 288, 298, 1074 Pledges of stock, 307 STOCK TRANSFER Continued Procedure, 296-311 Procedure of owner when refused, 288 Register, 1074, 1087 Restrictions on, 309 Signature on stock certificate, 316 Summary of rules, 325 System of, 17 Tax, 291 To and by administrator, 315, 319 To and by agent, 315, 317, 318 To and by corporation, 316, 322-324 To and by dummy owner, 316 To and by executors, 315, 317, 319 When taxable, 328 To and by guardians, 321 To and by joint owners, 316, 324 To and by married women, 315 To and by minors, 315, 320 To and by partnership, 324 To and by trustees, 315, 317, 320 To and by unincorporated body, 322 Transfer agents and registrars, 224 Transferees, 313 Transferrers, 313 Treasury stock, 107, 302, 322 Uniform transfer act, 83, 307 Voting trust, 327 STOCK TRANSFER TAX Federal, 30, 329 State, 28, 328 STOCKHOLDERS, n (See also "Preferred Divi- dends") Additional capital supplied by, 799, 805, Approval of consolidation, 1286 [1020 As incorporators, 174 Assessment of, 1020 By-laws, 228-234 Forms, 1464, 1467 Close corporation, 513 Corporations as, 482 Directors act as trustees for, 148 Directors as, 192, 236 Dividends payable to, 439, 1143 Dummy, liability of, 316 Exploitation by, 979-991 Functions, 132 Good-will of, 800 Interests in reorganizations, ion Liability, 14, 143-148 Bonus stock without par value, 1141 Full-paid stock, 101 In California, 53 Statutory, 145 Unpaid outstanding stock, 145 Unpaid subscriptions, 143 Watered tock, 100 INDEX 1685 STOCKHOLDERS Continued List of, 231. 338, 485 Form, 1 553 Listed in stock ledger, 291 Loss of stock certificate, 81 Majority (See "Majority Stockholders") Married women as, 315 Meetings (See "Meetings, Stockholders") Minority (See "Minority Stockholders") Number of, 584. 796 Refusal of corporation to transfer stock, 288 Relation to treasurer, 385 Rights, 132 (See also "Preferred Stock") Amendment of charter, 132, 141 By-laws, 141, 217 Certificates of stock, 223 Consent for the issue of preferred stock, 88 Consent to liquidation, 137, 142 Directors elected by, 142, 154, 238 Directors removed by, 153, 238 Dividends, 135, 428 Holding companies, 482 Inspection of books, 137, 484 Inspection of minutes, 369 Limitation of, 140 Liquidations, 137, 142 Married women, 315, 441 No-par-value stock, 126 Notice of meeting, 133 Officers appointed by, 157 Participation, in dividends, 135, 428 Sale of assets, 142 Special, 143 Special charter provisions, 139 Statutory, 140 Stock rights, 136, 805-813 Violation of, 139 Signature, 300 Status in foreign countries, 578 Status of, 131, 576 Stock system, 17 Subscription contract, 34 Subscriptions paid for in dividends, 430, 1149 Treasurer's reports to, 413 Vote cannot be withheld, 348 Votes, 231, 347-349 Cumulative, 202, 349 Preferred stock, 88, 90, 95 SUBSCRIPTION, 33-41 (See also "Capital Stock," "Certificate of Stock") Forms, 1474-1483 Acceptance, 34 At first directors' meeting, 281 Additional, 136, 805 SUBSCRIPTION Continued Adopted at first directors' meeting, 281 Assessment, Notice of, form, 1570 Assignments, Form, 1509 Balance sheet entry, 1361 Bonds, 1196 Cancellation, accounting entry, 1081, 1087, 1163 Common law rule, 40 Contract, mistakes in, 38 Dividends used in payment for, 430, 1149 Enforcement, 35 New York rule, 36 Entries, 1065, 1076 Forfeited, accounting entries, 1163 Form of list, 38 Full-paid at once, accounting method, 1068-1075 Instalment payments, 222, 1077 Account, 1090 Form, 1635 Instalment book, 1088 Ledger entries, 1093 Methods of entry, 1091-1095 Notice, form, 1569 Irrevocable when part of statutory form, 36 Journal, 1084, 1086 Form, 1634 Journal entries Stock not paid in full, 1076 Stock paid in full, 1068 Ledger, 1080 Instalment payments, 1093 Posting, 1086 Liability of subscriber, 34 Material variation in, 39 Not full-paid at once, accounting, 1076- 1085 Old rule for issuing stock, 80 Payment, accounting entries, 1086 Receipts, Forms, 1479-1483 Source of capital, 791 Stock, 33-41, 80 Stock account, 1077, 1083 Subscribed account, 1078 Transfer journal, 1082, 1088 Treasury stock, 1077 Unpaid, Notice of sale of, form, 1571 Stockholders' liability, 144 Surplus created from, 1060 Vs. agreement to buy stock, 37 Waiver of notice of assessment, Form, 1503 1 686 INDEX SUBSIDIARY CORPORATIONS (See "Affiliated and Subsidiary Corporations") SUITS AT LAW AGAINST CORPORATION, 15 SURETY COMPANY, Treasurer's bonds, 406 SURPLUS (See also "Reserves") Account, Analysis, 1039 Correction of errors adjusted through, 1040 Income tax charged against, 1042, 1044 Non-stock corporation, 1130 Accounting methods, 1038-1046 Analysis of, 1369 Appreciated, 1060 Balance sheet, consolidated adjustment on, 1380, 1381 Balance sheet entry, 1364-1367, 1369 Balance sheet item, 1038 Banks, 1056, 1098 Capital, 1058 From no-par-value stock, 1114, 1117 Capitalization, 682 Closing into, 1352 Consolidated, 1063 Contributed (See "Surplus Paid-in") Defined, 908, 1038, 1056 Diminishing, 1056 Dividend paid out of, 424, 898, 1047 Dividends to represent, 106 Donated, 1063, 1108 Earned, 913 Account, 1057 No-par-value stock corporations, 1117 From revaluation of assets, 911 From sale of securities or fixed assets, 910 Impounding, 1047, 1051 Impounding accounting methods, 1048 Income tax return, 1415 Investment of, 1046 Paid-in, Analysis of, 1058 Dividends paid out of, 1059 From assessment of stock, 1059 From assets purchased for stock, 1060 From payments on subscriptions for- feited, 1060 From premium on stock, 1038, 1098 From reduction of par-value of capital stock, 1059 Sources of, 1059 Part of net worth, 1038 Policy as to, 913-918 Purchased, 909 Reduction of, 1038 Secret, 920 Source of capital, 918 SURPLUS Continued Sources of, 909, 1038 Specific assets not represented by, 1045 SURPLUS AND DEFICIT ACCOUNT, 1353 SYNDICATES (See also "Underwriting") Nature of, 530 TAXATION OF CORPORATIONS, Capital stock tax, 30, 330 Disadvantage, 22 Evasion of, 64-66 Excess profits tax, 29, 332-1499 Excessive, effects of, 64 Express trusts, 542 Federal taxes, 29 Foreign corporations, 27, 28 Franchise tax, 25, 60, 333 Comparative table of, 61 Income tax, Accounting, 1042-1045 Federal, 29, 331, 501 Preparation of federal returns, 1399-1421 State, 26, 334 Inheritance Tax, Federal, 30 State, 27 No-par-value stock, 128, 329 Organization fees, 25, 60-66, 126 Partnerships vs., 501 Property tax, 26, 64, 333 Reports, 30 Stock transfer tax, 28, 30, 291, 327-330 Summary of, 24 TERM OF OFFICE, Directors, 196, 237 Officers, 158 TERMINAL BONDS, 464, TIMBER COMPANIES, Sinking funds for bond redemption, 660 TIMBER, VALUATION, 911 TIME, Annual meeting, 228 Directors' meetings, 239, 358 TRADE ACCEPTANCE, 706, 856 TRADE ASSOCIATIONS, 520 TRANSFER AGENTS AND REGISTRARS, By-laws, 224 Liability in selling bonds, 458 Procedure for, 303 Registrar's procedure, 303 TRANSFER OF STOCK (See "Stock Transfer") TREASURER, 12, 377-414 Affidavit to statement, Form, 1604 Assistant, 380 INDEX 1687 TREASURER Continued Authority, 377 Exceeding, 396 Bond, 283, 401-411 Form, 1616 Amount, 404 Bondsmen's liability, 408 Corporate requirements, 402 Defined, 401 Nature, 403 Personal, 405 Statutory requirements, 402 Surety company, 406 Termination, 410 By-laws, 255, 377-381 Forms, 1472 Corporate funds, 377, 415-419 Criminal act by, 398 Duties, As agent, 393 Assumption of office, procedure for. 382 Auditing of books, 383 Corporate funds, 377, 415 Faulty performance, 395 Responsible for books of accounts, 38i Signature on certificates of stock, 392 Specified in by-laws, 255, 377-381 Supplemented by resolutions of directors, 38i Faulty performance of duty, 395 Illegal acts, 398 Liability, 393-400 Corporate funds, 416 To whom liable, 393 Neglect of duty, 394 Newly elected, 381 Payment of dividends by, 423 Powers, 377-385 Relations to, Auditor, or comptroller, 389 Directors, 385 Finance committee, 387 President, 391 Secretary, 391 Stockholders, 385 Report, Form, 1629 Directors, 412 Stockholders, 413 Resignation, Form, 1581 Retiring, 382 Treasury stock shold not be assigned to, 107 Unauthorized acts, 396 TREASURY BONDS, Defined, 1186 Held in sinking fund, 1241 Interest, 1208 Unissued sometimes called, 1185 TREASURY STOCK, 104-110 Account, 1 10 1 Accounting, 1101-1112 Entries for donated stock, 1108-1112 Entries for purchase, 1102, 1104 Entries for sale, 1103, 1105 Acquisition of, 105, 322 By-laws, 226 Contingent profit on purchase, 1102 Defined, 84, 1101 Dividends, 433, 441 Donated, Accounting treatment, 1106-1112, 1162, Reasons for, 1 1 06 [ii79 Stock account, 1108 Full-paid stock, 104 Issued, 104 Legal status of, 109 No-par value, 1125 Repurchased, accounting, 1101-1105 Stock of other corporations, 109 Stock of other corporations not, 1136 Subscription account, 1077 Transfer of, 107, 302 Unissued a misnomer for, 104 TRUST AGREEMENT (See "Deed of Trust") TRUST FUNDS, Hospital Accounts, 1130 Nature of, 1225 TRUSTEES, Acceptance of subscription, 35 Bond certificate, Form, 1623 Deeds of trust, 615 Directors as, 148 Express trusts, 548-551 Legal functions, 533 Who may be, 534 Precorporate contracts, 48 Sinking funds, 657, 1236 Accounts of, 1245 Stock transfer by, 315, 317, 320 Stock transferred to and by unincorporated Votes, 135 [body, 322 TRUSTS (See also "Express Trusts") Harmful, Taxation no remedy against, 22 Succeeded by holding company, 590 TURNOVER, Affecting working capital, 701 Defined, 701 Rate of, 702-705, 955 1 688 INDEX ULTRA VIRES ACTS, 185 UNCERTAIN ENTERPRISES, Capitalization of, 74 UNDERWRITING, Advantages, 838 Agreements, 40, 842, 1172 Banking arrangements, 839 Commissions, 844, 1174, 1179 Community of interests between houses, Expenses, 1174 [840 Origin, 837 Plans, American Woolen Company, 847 United States Realty and Construction Company, 845 United States Shipbuilding Company, 846 Speculative, 843 Syndicate, 823, 839 For reorganization, 1023 Manager, 844 UNDIVIDED PROFITS (See "Profit") UNITED STATES CONSTITUTION, Corporations not citizens under, 51 UNITED STATES EXPRESS COMPANY, Dissolution of, 1002 UNITED STATES REALTY AND CONSTRUCTION COMPANY, Underwriting syndicate, 845 UNITED STATES SHIPBUILDING COMPANY, Exploitation of, 971 Underwriting syndicate, 846 UNITED STATES STEEL CORPORATION, Incorporation of, 176 UNLOADING, 975 VACANCIES, Board of directors, 154, 238 Officers, 259 VALUATION, Capitalization, 676 Good-will, 678-681, 1166 Inventories, cost or market, 870 Property, mortgage ratio, 627 Revaluation, 911 Stock, No-par value, 130, 1114 Subsidiary corporations, 1136 VERTICAL TRUST OR COMBINE, 737 VICE-PRESIDENTS, 12 By-laws, Forms, 1471 Presiding officers, 253 VOLUNTARY ASSOCIATION (See "Express Trusts") VOTING, Administrators, 135 By ballot, 346 By-laws, 231 By proxy, 135, 233, 342 Directors may not, 364 California provides no preference, 96 Certified list of stockholders, 231 Corporation cannot vote, 348 Cumulative, 202, 349, 487 Election of officers, 366 Executors, 135 Face value of stock as affecting, 80, 85 Injunction aginst stockholders, 348 Method of casting votes, 134 Methods at annual meeting, 347 Minority interests, 202, 487 Partnerships .incorporated, 506 Preferred stock rights to, 88, 90, 95. 601, 602, 608 Stock as voting and non-voting classes, 203 Stockholders' rights, 133 Trustees, 135 What constitutes majority votes, 347 Who is entitled to vote, 343, 347 VOTING TRUST, Agreements, Form, 1517 As a minority protection, 490 Defined, 467 Dissolution, 470 Dividends, 470 Illegal, 472 Object, 468 Organization, 469 Preservation of agreed status by means of, 506 Restriction of sale of stock, 472 Stabilizes management, 197 Statutory laws, 470 Stock, 470 Stock certificate. Form, 1491 Stock transfer liable to tax, 327 w WAIVER OF NOTICE, First stockholders' meeting, 268, 272 WAIVER OF NOTICE OF ASSESSMENT, Form, 1503 WAREHOUSE RECEIPTS, As collateral, 863 WARRANTS, Stock rights, 805 INDEX 1689 WATERED STOCK, 85, 99 WEBB-POMERENE LAW, 590 WEST VIRGINIA, Incorporation in, 56 WESTINGHOUSE ELECTRIC AND MANUFAC- TURING COMPANY, Reorganization, 688-691 WITHOUT PAR VALUE (See "No-Par Value") WOMEN, Married, Signature on stock certificate, 317 Stock ownership rights, 315, 441 WORKING CAPITAL, Denned, 687, 697 Donated stock, 1107 Account, 1108 WORKING CAPITAL Continued Factors affecting, 697-707 Credit, 708 Discounts, 705 Long term manufacture, 698 Terms of purchase, 705 Terms of sale, 708 Time element, 699 Turnover, 701 Lack of, a cause of insolvency, 995 Requirements, 691-693, 697-719 Foreign trade, 708 Instalment business, 709-713 Liquidity of assets, 713 Month-to-month, 718'' Ratio, 949 Seasonal trades, 717 LAW LIBRARY UNIVERSITY OF CALIFORNIA LOS ANGELES UC SOUTHERN REGIONAL LIBRARY FACILITY A 000 704 829 1