Part 8

Directors sometimes go astray and cases are constantly arising to determine their liability. When a corporation has failed or passed a dividend nothing is more common than to accuse its directors of negligence, incompetence or fraud. The legal rule of liability is quite a different thing. Let us try to give this in the fewest words possible. The charters of corporations, or statutes that apply to directors, prescribe some definite things which they must do or not do, and if these are violated they are clearly liable. The directors of a bank are required to make a statement of its affairs to a government official at a stated period, and if they neglect to do it, or intentionally make a wrong and deceptive one, they are liable. By many statutes they are forbidden to make loans above a certain amount, or a fixed proportion of their bank's capital, and if they violate this plain law they are liable. In all other cases where by charter or statute a plain rule of duty is prescribed for directors, they are liable, should they disregard it.

Besides these clearly defined lines of duty are other lines of duty in which the proper course of action is not so clearly defined, indeed is largely discretionary. From the nature of the business of almost any kind of corporation, it is impossible to prescribe in detail the course of action directors must follow. Much must be left to their judgment. They must on all occasions be honest and free from fraud. This is one limitation. If they are guilty of doing things tainted or marked with fraud, they are liable. Fraud may be of two kinds, omission and commission. If a director knew that his fellow directors were doing fraudulent things, and he kept away from directors' meetings because he did not wish to participate in their wrongdoing, or dared not go and try to stop them, or kept silent when he should have exposed them, he must suffer in the end as one of the number though entirely innocent of actual participation in the fraud. Many a director knowing or suspecting with good reason that his fellow directors were running the corporation in an illegal manner, has quietly sold out leaving the stockholders to find out afterwards and from some other source about the wrongdoing of their agents. In all such cases of omission of duty a director is held responsible for the wrongs of his associates.

Recently a court has declared that a director who desires to escape further responsibility by resigning his position must make sure that his resignation reaches the board. If therefore he should send it to the secretary, who failed to deliver it to the board, his resignation would not be effective and he would still be responsible like the other directors for whatever the board might do.

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

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

DIVIDENDS.

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

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

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

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

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

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

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

To whom should the dividend be paid? To the person whose name appears as owner on the books of the company. But if a company has notice of a transfer of stock, a dividend subsequently declared should be paid to the purchaser even though the transfer was not registered. In pledging stock it is a common practice to declare that the pledgee shall be entitled to the dividends that are declared. If nothing is said, and the stock has been transferred on the books of the company, the pledgee is entitled to the dividends following the general rule above mentioned.

A dividend may be payable in cash or property or a stock dividend may be made. Such a dividend, if the stock is issued only to the extent of the surplus profits, is not a violation of the prohibition against reducing or withdrawing the capital stock by distribution among the stockholders.

During recent years some important questions have arisen about dividends or income on stock given by will to the legatees or friends of the testator. Dividends that are declared after a grant or bequest, though earned before, go to the legatee as income. This is not the rule everywhere. In some states the surplus profits accumulated during the testator's life, though not divided until after his death, belong to the estate, while the dividends or income earned and declared after his death are paid to the legatee or beneficiary mentioned in the will. Again, a somewhat different rule applies to stock dividends. In some states these are regarded as an increase of capital and must be kept as a part of the estate; in other states such stock is regarded simply as another form of income and goes to the legatee like any other income flowing from the investment. The highest federal court has declared that when a distribution of earnings is made by a corporation among its stockholders, the question whether such distribution is an apportionment of additional stock representing capital, or a division of profits and income, depends upon the substance and intent of the action of the corporation, as manifested by its vote or resolution; and ordinarily a dividend declared in stock is to be deemed capital, and a dividend in money is to be deemed income of each share.

A will bequeathed stock in a corporation in trust to pay the dividends as they accrued to a daughter of the testator during her lifetime. Stock dividends were declared by the corporation from time to time and after the death of the testator, and these accumulated earnings were invested by the company in permanent works. After the testator's death the corporation was authorized by statute to increase its capital stock. The dividends were held to be accretions to the capital, and the income only was payable to the daughter for life.

WRONGS.

Passing from the action of directors in declaring dividends, the wrongs done by corporations may be stated. As it is an impersonal, artificial thing, a corporation cannot possibly commit a wrong or tort like a natural person. For many years this conception of a corporation, that it could not commit many of the well-known wrongs, could not slander a person for example, led to perplexing consequences. Finally the principle was established that through its agents or servants a corporation could do wrong quite like an individual. Thus a corporation may be guilty of malice, and may be punished for slander or libel, for a malicious prosecution, false representation, for trespass should its agents unlawfully enter on the land of another, for maintaining a nuisance and the like. A national bank is forbidden to certify the check of a depositor unless he has the amount of money stated in the check in the bank. And if this is done the certifying official and all others who participated with him in disregarding the law are made criminally liable, and on several occasions the law has been enforced.

Again, a corporation is liable for the negligence of its servants in performing their duties, and are constantly sued for their failures. A railroad company is sued for injuries to its passengers caused by the improper running of its trains; for its failure to carry and deliver freight in accordance with its obligations or agreements. Street railways are constantly sued by passengers who are injured through the negligence of its officials.

By statutes corporations are required to do many things and, if they fail, are liable for the consequences. These duties may be divided into two classes, those toward the public and those that affect their stockholders. Their public duties may again be divided into those that are imposed on them by statute, and a still larger number by the common law. As we have seen, stockholders confide necessarily the management of their corporation to directors, who in most cases must necessarily have a largely discretionary power, and who, in turn, must appoint other agents to execute the details of the corporate business. These not infrequently fail through incompetence or neglect to perform their duties properly, and consequently corporations are subjected to lawsuits in which redress is sought by the injured parties. Some of these wrongs for which they are liable to the public have been mentioned, it would require too much space to mention all.

The injuries done to stockholders by their directors remain for consideration. Unless directors are restricted by action of the stockholders at a stockholders' meeting, they have the authority prescribed by charter and statute; outside these, their authority is largely discretionary, and must be so. If, therefore, stockholders are dissatisfied with their directors, as they often are, their remedy is to elect others at the end of their term of service. If at the time of choosing them, the annual meeting, none are chosen, the directors hold over until they are again elected, or others are chosen in their places. After they have been chosen, no stockholder can interfere in any way with their discretionary authority unless he has a clear case calling for judicial action. "Until a mistake," says Morawetz, "on the part of the directors, individual stockholders have no right to appeal to the courts to define the line of policy to be pursued by the company. The courts therefore are quite unanimous in sustaining the action of directors so long as they act within the discretionary authority given them."

Occasions happen when the removal of directors is essential to the welfare of a corporation. Suppose they are pursuing a course clearly ruinous to the company? In such a case the court will grant relief on the request of the stockholders whenever the corporation itself is unable or unwilling to do so. Primarily the corporation should proceed against the directors, for the wrong is a corporate one. In many cases the corporation is so completely in their control that the stockholders are unable to do anything through it. In such case they must act in the name of, and in behalf of the company. And if they succeed in establishing their case, the courts will order the removal of the directors.

Sometimes the courts, instead of going so far, will enjoin them from doing wrongs that are feared. Suppose it is feared that directors will declare a dividend that has not been earned, the courts on proper proof would enjoin them from making it. Suppose it is feared they will issue more stock and divide all the shares among themselves instead of proportionately among all the stockholders as the law requires, in order to get control of the company, a court would not hesitate to restrain them.

Lastly may be considered a stockholder's rights to inspect the books of his company. This he may do at all proper times and for reasonable purposes. And if the right is refused the courts will aid him in making an inspection. What then is a proper purpose that justifies him in making the request? He cannot do so to satisfy some freak, or to annoy an official with whom he may be on bad terms. Nor can he do it to obtain information to be used for stock-jobbing purposes. Suppose he has reason for supposing that the books were falsified, that the stockholders were not receiving correct accounts of the expenditures and earnings of the company, a stockholder would certainly have a right to make an examination, and could also employ an agent, attorney, or expert accountant to do this for him, for his ignorance of bookkeeping methods might debar him from making an efficient examination were the right confined exclusively to himself.

=Curtesy.=--A husband acquires an interest or estate in land belonging to his wife after her death. To be entitled to it, there must be a legal marriage. Even though it be unlawful, if not set aside during her life, his interest in her estate cannot be defeated by afterwards declaring the marriage void. Curtesy does not extend to land nominally held by her, or as trustee. The wife must have had a child who might have inherited the estate. It is immaterial whether she acquired her estate before or after the birth of the child. As soon therefore as a child is born, his estate or interest begins and is perfected or consummated by her death, and may be taken at any time afterward for his debts. What may be the effect of a divorce is not well settled. In some states even though he is an innocent party, he forfeits his estate. This rule is founded on the idea that he is a voluntary party, and therefore need not have one; in other states his interest continues. As the husband's rights to such an estate have been abolished in many states, we refrain from adding more principles.

=Deceit.=--A seller is not liable for deceit when the knowledge, or way of obtaining it, is equally known by both parties. If one goes into a store to buy a bushel of apples that he has seen by the door and inquires the price and pays for them without making any inquiry concerning their quality, he cannot recover his money if half of them prove to be rotten unless the seller intentionally deceived him, for he might have inquired whether they were all like those on top and of good quality. But if the merchant should put fine ones on top in order to deceive a purchaser, he could recover for his loss. This rule has a wide application. Suppose a seller keeps his store dimly lighted intentionally so that the inferior quality of his goods cannot be discerned, and a person should thereby be deceived and injured, he would have a good cause of action against the seller. Suppose a ship was decayed in places, and these were intentionally so concealed that they could not easily be seen by one who was examining with the intention of purchasing, and he was thereby misled, the seller would be liable for the loss to the purchaser. Of course, the prudent course is to obtain a warranty, or better still, whenever practicable, buy of one who has established a reputation for honest, fair dealing.

Suppose a man purchases a piece of land, generally supposed to be an ordinary farm, which contains, as he knows, a valuable coal mine, can the seller after the public knowledge of the mine, recover the land or a larger purchase price therefor? Has the purchaser deceived him? Did the law require the purchaser to make known his superior knowledge before purchasing? No, if it did, there would be no end to the confusion to which such a rule would lead. It is within ordinary experience that purchasers buy either knowing or supposing they will reap advantages from their contracts of which the seller is ignorant. There is no deception in this; but there is in withholding knowledge from the buyer of the quality or condition of a thing that affects its value, and which if known by him would probably prevent him from purchasing. Suppose a horse is blind in one eye and the prudent horse trader says nothing. Can the buyer recover? Ordinarily he could not, for he ought to have looked, and if he did not know enough to look, either he should have obtained a warranty, or have employed a competent agent to purchase for him. Suppose the old trader, skilled in his business, intentionally put his horse in the shadow so that the defective eye could not be seen, then the seller would surely have his remedy against him. If he put his horse there accidentally he would not.

Is a wink a deception for which the winker must answer in the law? A hardened dealer once went near a large meeting of men with a wagon load of bottles containing cold tea. The thirsty crowd soon came around. "One dollar a piece," he announced with a wink. The wink was effective and the bottles were quickly sold. They were filled with cold tea, and the buyers sued for the deceit that had been practiced on them. They failed, the court said that a wink was not enough. Another court might have decided otherwise.

=Deeds.=--In selling and buying land several deeds are in use. The forms differ considerably in the different states. The most important of them is called a warranty deed, in which the seller not only conveys the title, but warrants or agrees to defend it against all attacks. Suppose A sells a piece of land by warranty deed to B, who makes the unwelcome discovery that a mortgage is existing thereon. He notifies A and asks him to clear the title. Suppose the mortgage has been paid, but the lender of the money, the mortgagee, forgot to give the proper deed to show that he had received payment. And suppose he was an ugly fellow who would not give the proper release. B could compel him to do so, and the expense must be borne by A because his deed of warranty required him to give a clear title.

In such a deed the grantor or seller agrees or covenants to do usually four or more specific things: first, he asserts that he has a right to convey the land at the time of the sale. Of course, if he has not, the agreement or covenant is at once broken and the buyer can proceed against him to make the title good, or to recover damages if he cannot retain the premises. The second covenant or agreement is to the effect that the seller has both the quantity and quality of land mentioned in the deed. The third covenant is that there are no encumbrances on the land, that is, no mortgages, no rights of others to pass over it, or to take earth, water or other things from the land. The fourth covenant is for the quiet enjoyment of the land, which is the most general form of warranty. There may be other covenants, often there are, while the four mentioned may be, and often are, modified.

Does such a warranty bind other persons than the warrantor, in other words are his heirs and persons to whom he may devise his lands also indefinitely bound by his warranty? The statutes in some states fix his liability. Where none exist the law limits the liability of parties to the amount of assets or property they have received from the warrantor; if they have received nothing they are not liable for anything.

A covenant to protect the buyer from encumbrances, claims, etc., does not always relieve him from the expense of a lawsuit. Suppose A claims a right of way over B's land and insists on using it. B brings his action of trespass against him and wins. He cannot sue his grantor or seller to recover the expense of the suit, for the latter would reply, "You have won your case which is proof that the title is good as warranted, and therefore you have no claim against me." If, on the other hand, A had won his case B would then have a good cause of action against his covenantor.