Opinion
August 16, 1938.
Suit by Joseph Havender, Sr., and another against the Federal United Corporation to declare void as against the complainants a plan of recapitalization and readjustment of the capital structure of the defendant, accomplished by a merger and for injunctive relief.
Decree for complainants in accordance with opinion.
Bill to declare void as against the complainants a plan of recapitalization and readjustment of the capital structure of the defendant corporation, a Delaware corporation, accomplished by a merger of the defendant with Corporation Bond and Share Company, a Delaware corporation, and a one hundred per cent. owned subsidiary of the defendant. The proposal of merger was submitted to the stockholders of the two corporations on November 30, 1936, after full notice of its details had been sent to them on November 4, 1936. The procedural requirements of the statute, Section 59 of the General Corporation Law, § 2091, Revised Code 1935, were complied with.
The defendant was incorporated on January 25, 1932. The capital stock upon incorporation and until the merger with its subsidiary, consisted of five hundred and fifty thousand shares without par value, of which fifty thousand shares were six dollar cumulative preferred stock, one hundred thousand shares were Class A common stock and four hundred thousand shares were Class B common stock. In addition to preferential dividend rights over the two common stocks, the preferred stock was entitled to receive on liquidation or dissolution one hundred dollars per share plus a sum equal to accumulated and unpaid dividends before anything should be paid to the common stocks. It was also redeemable at any time in whole or in part at one hundred dollars per share plus accumulated dividends. The preferred stock had no voting powers except in case dividends thereon were in arrear to an amount equal to six dollars, in which event, so long as the arrearage in that amount continued, it became entitled to equal voting rights with the two classes of common stock.
The complainant, Havender, Sr., owned one thousand shares and the complainant Havender, Jr., owned forty-four shares, of the six dollar preferred stock.
When the merger was accomplished, dividends were accumulated on each share of the preferred stock in the amount of twenty-eight dollars and fifty cents.
The merger agreement provided that the defendant would absorb the subsidiary and thereafter the defendant should be the continuing or surviving corporation of both. Its terms provided for the alteration of the capital structure of the defendant as the continuing corporation. Since the merger, the defendant's authorized capital stock consists of six hundred and twenty-five thousand shares, of which twenty-five thousand are preferred shares, each of the par value of fifty dollars, calling for a preferential cumulative dividend of three dollars per annum, for a preferential liquidation or dissolution value of fifty-five dollars per share plus an amount equal to accumulated and unpaid dividends and redeemable in whole or in part at the rate of fifty-five dollars per share plus a like amount. The new three dollar preferred stock has no voting rights except in the event that dividends become in arrear in the amount of three dollars per share. In that case a voting power arises and continues as long as the arrearage in that amount continues.
The terms of the merger provided further that all the outstanding stock of the subsidiary consisting of one thousand and ten no par shares should be cancelled and that the defendant as the holder of all those shares should receive nothing in exchange therefor.
With respect to the old six dollar preferred stock, the merger agreement provided that each share thereof with its right to the twenty-eight dollars and fifty cents of dividends accumulated thereon, should become converted into one share of the new three dollar preferred stock and six shares of the Class A common stock, and that a holder of old six dollar cumulative preferred stock would, upon surrender of his old certificate, receive in exchange certificates for the new shares on the above basis.
The complainants refused their assent to the plan of merger because, particularly, of the manner in which it assumed to compel the holders of the old preferred stock to surrender their right to be paid the dividends accumulated thereon in accordance with the charter provisions as the same existed when the stock was issued.
Before the stockholders voted on the merger proposal on November 30, 1936, the complainants, to-wit, on November 24, 1936, notified the defendant that they were opposed to the plan. More than the requisite statutory majority of two-thirds having voted in favor thereof, the merger was declared authorized and further steps necessary to comply with the statutory procedure were taken to bring it to completion.
The complainants refused to accept the merger as lawful and refused to surrender their old certificates for exchange. When the bill was filed, quarterly dividends on the new three dollar preferred stock had been declared on December 1, 1936, and April 1, 1937, respectively. The defendant insisted that the complainants should, before the dividends were paid to them, surrender their old shares for exchange into the new. This, the complainants refused and continue to refuse to do. Correspondence was carried on between the complainants and the defendant about the matter. Complainants on April 1, 1937, employed counsel to protect their rights and on June 30, 1937, after it became apparent that the parties entertained irreconcilable views upon the legal validity of all that had been attempted to be accomplished, the bill in the pending cause was filed.
The prayers of the bill are that the purported amendment of the defendant's certificate of incorporation which was adopted in execution of the plan of merger be decreed to be null and void in so far as it purports to change each share of the old six dollar cumulative preferred stock of the complainant into one share of new three dollar preferred stock and six shares of Class A common stock; that the old six dollar preferred stock of the complainants be decreed to be of continuing validity and to be entitled to all the rights appertaining thereto as defined in the defendant's original certificate of incorporation as filed on January 25, 1932; that the complainants be decreed to be entitled to all the unpaid dividends which had accumulated on their old preferred shares before any dividends are paid to the holders of the new three dollar preferred stock or of the common stock of either class; that appropriate injunctive relief to that end be granted; and for general relief.
The cause was heard on bill, answer, testimony of witnesses taken orally before the Chancellor and exhibits.
Charles L. Terry, Jr. (of Hughes, Terry Terry), of Dover, and Abraham L. Pomerantz, of New York City (Abraham Marcus, James Havender, and Leonard I. Schreiber, all of New York City, on the brief), for complainants.
Caleb S. Layton (of Richards, Layton Finger), of Wilmington, for defendant.
THE CHANCELLOR.
The complainants on their brief confine their objection to the alteration in the rights of the old six dollar cumulative preferred stock to that phase of the alteration which is concerned with the attempted destruction of their right to be paid in cash the amount of the unpaid dividends which were accumulated thereon at the date of the merger. They make no contention with respect either to the change of rate operating in the future, or the alteration in voting powers, or the alteration in the liquidation or dissolution value of their stock or in its redemption price. Neither do they contend that the basis of exchange is unfair, if the power exists to compel it.
I shall accordingly confine this opinion to a consideration of the point to which the complainants have confined their contention in their briefs of argument.
The contention is that it was not in the power of the defendant to accomplish by merger proceedings the result of destroying the right of the complainants to be paid out of the earnings of the company the dividends accumulated on their stock when the earnings are such in the judgment of the directors as to warrant a dividend declaration.
If the defendant had attempted by way of the usual method of amending its certificate of incorporation under Section 26 of the act, § 2058, Revised Code 1935, to extinguish the right of its six dollar preferred stockholders to receive in cash the dividends accumulated on their stock by compelling them to take in lieu thereof allotments of new shares into which the amendment undertook to reclassify the old ones, the attempt would have been futile. The Supreme Court of this State so decided in Keller et al. v. Wilson Co., Inc., Del.Sup., 190 A. 115, reversing Del.Ch., 180 A. 584, and in Consolidated Film Industries v. Johnson, Del.Sup., 197 A. 489, affirming Del.Ch., 194 A. 844.
But the defendant contends the principle of those cases is not applicable here, because this is a case of merger under the provisions of Section 59 of the statute, section 2091, Revised Code 1935, and that distinguishing features therefore exist. The section, it is said, authorizes the merger or consolidation of two or more corporations into one, either by the absorption by one of the other or others, or by the absorption of all by a new corporation; and where that takes place the only recourse, says the defendant, which any stockholder of one of the constituent companies has for an injury which he conceives the merger works upon him, is to make his protest in writing and follow the procedure outlined in Section 61 of the Act, section 2093, Revised Code 1935, to secure the valuation of his stock and payment thereof. As the complainants did not pursue this course, the defendant insists that the complainants are compelled to accept the alternative of submission to the terms of the merger.
The complainants take the position, if I correctly comprehend the extent to which their argument goes, that in no case whatever can the holders of cumulative preferred stock of one of the merging companies, on which dividends are accumulated, be compelled to make the choice between, on the one hand, being bought out of the corporation at a valuation price, and, on the other, staying in the corporation and surrendering their claim to the accumulated dividends. This contention means that dividends accumulated on preferred stock of one of the merging companies cannot in any case be the subject of composition in the merger terms except by a provision for cash payment thereof in accordance with the stipulated priority. This is a broad contention. Its acceptance or rejection in the broad terms in which it is stated should be only after a full and deliberate examination of considerations which suggest themselves as open to inquiry.
I do not feel called upon by the facts of the instant case to embark upon such an examination.
I say this because I am of the opinion that the so-called merger which the facts disclose here, is at best a mere technical thing in its relation to the complainants' right to be paid the dividends on their preferred stock.
A merger of two corporations, as usually found, occurs when two corporations having a distinct body of stockholders desire to throw their assets and liabilities into a common pool and thereafter have their two enterprises operated and managed as one. Since each has its own particular stock structures applicable to separate and distinct asset and liability congeries, and since the value of the respective shares of each has no relation to the other's assets, it is therefore an inescapable consequence of a merger plan that the equities of each company's shares be translated into and stated in terms of shares having equities in the combination of the net assets of all the constituents. This of course involves the allocation of those combined net assets to the old shares of the constituents on a per share basis and perhaps the creation of new classes of stock in order to meet the demands of fair and just participations by the old shares. Hence the merger agreement may find it necessary, when one of the merging companies is to survive and continue as the combined one, for the latter to provide for new issues of stock and perhaps for new classes of stock, in order that the just and fair allocations may be made.
Thus a merger may involve a reclassification of the shares and a revamping of the capital structure of the surviving company. But such reclassification or readjustment of capital, it is to be observed, is only incidental and collateral to the primary purpose of distributing the values to the contributing groups of stockholders. Capital readjustments and stock reclassifications are not ends which it is the function of mergers to accomplish. They are only subsidiary mechanics which the principal end of the combining and blending operation upon the corporate creatures and their businesses makes necessary to be employed.
Now, what do we have here? We have the parent corporation absorbing its one hundred per cent owned subsidiary. There was no problem of adjusting the relative rights of stockholding members of the two corporations. That is convincingly shown by the fact that the defendant as sole stockholder of one of the merging corporations, viz., the wholly owned subsidiary, received no stock whatever in the continuing one, itself. The defendant as sole owner of the subsidiary received nothing. If it had, it would have been solely for the benefit of its own stockholders, its equitable owners. It was a case of the defendant simply taking over the assets of its own subsidiary and becoming the immediate instead of the derivative owner thereof.
There was thus no occasion for any reorganization or reclassification of its own capital structure to the end that the equities of its stockholders might be adjusted to a new asset and liability situation and brought in fair relation with the rights of a new group. So far as the combined assets of these two merging corporations are concerned, the defendant's stockholders stood in relation thereto exactly in the same identical position of ultimate rights as owners after the merger as they did before. Before the merger those assets were theirs in the eyes of equity, though not in point of legal title, because their corporation, the defendant, owned all the stock of the subsidiary which had the assets. After the merger, the only change was that one intermediary between the defendant's stockholders and the subsidiary's assets was eliminated as the legal owner.
The resort by the defendant to procedure under the merger section of the act was for the real purpose of reclassifying its stock and of readjusting its capital structure, so as to be able to rid itself of the troublesome problem of its obligation to discharge the dividends accumulated on its preferred stock by cash distribution from its earnings. Indeed the copy of the plan of merger which the defendant sent to its stockholders and the covering letter accompanying the same, contain language which clearly shows that such was the animating purpose. For instance in the former it is stated at the outset that "it is proposed to carry out a voluntary plan for the readjustment of the capital structure of Federal United Corporation by means of a merger of Federal United Corporation and Corporation Bond and Share Company"; and in the latter, the board of directors of the defendant informed the stockholders as follows — "Your directors have for some time been giving serious consideration to the formation of a plan of reorganization making possible the payment of dividends on the preferred stock of your Company. The result of their deliberations is the enclosed plan" of merger with Corporation Bond and Share company.
It is obvious that the defendant used its wholly owned subsidiary as a mere instrumentality under its control to go with it through the motions of a merger for the purpose of giving color of legality to what, under the cases hereinbefore cited, it was not permitted to do by way of an amendment of its certificate of incorporation.
The complainants were not required to make a choice between submitting to this circumvention of their rights as preferred stockholders by accepting the terms of the merger, on the one hand, or demanding a valuation of and payment for their stock on the other.
I am of the opinion that the merger was not conceived in any genuine purpose which mergers are designed to serve. Its object and aim was to reclassify the defendant's shares in a manner which the Supreme Court of this State has declared to be not permissible. If what the defendant did will stand the test of legal legitimacy, I can see no escape from the proposition that all a corporation needs to do to escape the results of the law as laid down by our Supreme Court, is to create a subsidiary for itself and then proceed to absorb it by merger. If it be said that deliberation to evade would be too conspicuous in that case to warrant overlooking it, the answer is that evasion cannot be any the more objectionable simply because it might be a little more conspicuous. The difference between using a wholly owned subsidiary already existing and using one specially created for the purpose, to accomplish by a merger an end which bears no preceptible relation to the problem involved in and incidental to the merging operation, is a difference which rests on no basis of substance.
For the reasons above given, I am of the opinion that the complainants are entitled to relief. Whether they are entitled, however, to an injunction, as prayed, against the payment of dividends on the new three dollar preferred stock until all the arrearages on the old preferred stock have been paid, is doubtful. I have some tentative ideas on that question which, however, I abstain from now elaborating. It has not been debated by the solicitors for the parties, and I prefer to hear from them before reaching a final conclusion with respect thereto. The complainants, however, are entitled to an injunction against declaration and payment of dividends on the two classes of common stock, until the arrearages have been paid which were accumulated on the old preferred.
A decree will be entered in harmony with the fundamental question which the foregoing disposes of, and further argument may be had, if desired, touching the question just referred to as doubtful.