Opinion
Argued May 2, 1958
Decided June 25, 1958
Appeal from the Appellate Division of the Supreme Court in the first judicial department, JACOB MARKOWITZ, J.
Frederick S. Beebe and George J. Gillespie, III, for appellants. Leo P. Dorsey for New York State Bankers Association, amicus curiae, in support of appellants' position.
Daniel G. Tenney, Jr., Webster Sandford and Leonard A. Blue for Chase Manhattan Bank and others, amici curiae, in support of appellants' position. C.O. Donahue and Louis S. Auchincloss for American Museum of Natural History, respondent.
This proceeding was instituted under article 79 of the Civil Practice Act for a construction of a deed of trust dated May 4, 1918. By that deed, which designated the petitioner City Bank Farmers Trust Company trustee, one Fosdick created two trusts for the lives, respectively, of two nieces. A grandniece was named as a secondary life beneficiary under each trust. The principals of the funds were originally made up of 300 shares of General Electric Company stock. As to each trust it was provided that on the death of the survivor of the income beneficiaries the principal was to be distributed to the settlor or his residuary estate. Fosdick reserved the right at any time during his life to revoke the instrument and repossess, free of all trusts, funds in the hands of the trustee. The trustee was given authority to retain, sell, invest or reinvest the principal securities or proceeds thereof, provided, if the settlor were still alive, that his written consent first be obtained. A special provision for the treatment of stock dividends, the subject of this proceeding, was inserted in the deed. It states: "Anything hereinabove contained to the contrary notwithstanding, said Trustee shall transfer to said Donor, or if he is dead, to his executor * * * free of all trusts hereby created, any and all stock dividends which it may from time to time receive on any stocks held by it hereunder." (Emphasis supplied.)
Fosdick died on April 6, 1926 without revoking or amending the trust. His will named the American Museum of Natural History sole residuary legatee. As such it would be entitled to any distributions of stock in the nature of stock dividends declared after the settlor's death.
The construction was sought with reference to certain stock distributions in 1954 from companies, shares in which then constituted the trust corpora. Special Term decided that both distributions, one by General Electric and the other by Standard Oil of Indiana, were in part stock dividends within the meaning of the trust deed. Appellants in this court have confined their argument to the former.
The stock distribution in question was made in the following manner. By April of 1954 the trustee held 1,200 shares of General Electric no par value common stock in each trust. The increase had resulted from stock splits in 1926 and 1929, both of which split the stock 4 for 1 and both of which were unaccompanied by any transfer of accumulated earnings to capital. The remaining shares received in the split but not part of the trust in 1954 had been reinvested. On April 20th of that year the General Electric stockholders adopted the following resolution at their annual meeting:
"RESOLVED:
(a) that the 35,000,000 shares of Common Stock without par value which the Company is presently authorized to issue be changed into 105,000,000 shares of Common Stock with a par value of $5 each on the basis that each such previously authorized share of Common Stock without par value, whether issued or unissued, shall be changed and converted into three shares of Common Stock having a par value of $5 each."
The petition described the proceedings taken by the corporation in conjunction with the resolution as follows:
"Prior to the change in the capitalization of said General Electric Company as aforesaid, it had issued 28,845,927.36 shares of its common stock without par value. These shares had a stated value for capital purposes of $6.25 each, resulting in a total capital of $180,287,046. Under the change in the company's capitalization as approved by the stockholders, the company will have issued 86,537,782.08 shares of stock having a par value of $5 each. As set forth above, the Board of Directors took the necessary action to provide that upon the adoption of the said resolutions by the stockholders the capital of the company be increased from $180,287,046 to $432,688,910.40 by the transfer of $252,401,864.40 from the company's reinvested earnings (earned surplus). Of the thus augmented capital of the corporation, 5/12ths is therefore attributed to its former capital and 7/12ths to the transfer to capital from reinvested earnings."
The effect of these proceedings was tersely summarized by the lower court. As pointed out in the opinion: (1) all the old stock was cancelled; (2) 36,057,409.2 shares of $5 par value stock (aggregate par $180,287,046) were issued for the old capital of $180,287,046; (3) 50,480,372.88 shares of $5 par value stock were issued and were backed by a capitalization of earned surplus in the amount of $252,401,864.40 which amount was equivalent to the aggregate par value of the said shares. Mathematically, 7/12ths of the new shares represented new capital, transferred, as pointed out, from earned surplus.
A proxy statement and notice of election sent before the adoption of the resolution suggested that the new stock distribution would serve a two-fold purpose, viz.: it would most likely reduce the market value of the individual shares thus rendering them more saleable and it would, by means of the low par value, result in a savings on the Federal transfer tax.
The lower court held that 7/12ths of the new stock which was attributed to the transfer from reinvested earnings to capital account constituted a stock dividend within the meaning of the trust deed and was distributable, therefore, to the residuary legatee as required by the instrument. He reached this conclusion by application of the definition of the term "stock dividends" as it appears in our decisional law. The Appellate Division unanimously affirmed his determination.
Appellants beneficiaries assert that the substance and intent of the distribution was not to distribute earnings, but rather was merely to split up the shares and apportion the additional capital and that, therefore, it did not constitute a stock dividend. They point out that distributions of stock, like the one under discussion, which substantially increase the number of shares outstanding, ordinarily reduce both the market value of and income upon the original shares so that in a case like the present one if the additional shares are permitted to leave the trust principals it will bring about a considerable reduction in the amount of annual income distributable to the beneficiaries. This result, it is concluded, could not have been intended by the settlor. Appellants also contend that even if the courts below were correct in finding that the distribution by General Electric was partially a dividend the number of shares allocable to the legatee under the trust deed should be no more than the number of shares equal in market value to the amount of surplus capitalized at the time of the change. The determination below held that that proportion of stock which represented new capital, without reference to market value, constituted the dividend. Concededly, that proportion was 7/12ths or 7,200 shares.
In our view the courts below were correct. The term "stock dividends" has been frequently the subject of litigation and has acquired a fixed judicial meaning which clearly includes the corporate action in question. Since before the execution of the subject deed in 1918 it has been held and understood that a stock dividend consists of a distribution of stock by a corporation to its shareholders evidencing and accompanied by the transfer of accumulated surplus to the corporation's capital account (see Equitable Trust Co. v. Prentice, 250 N.Y. 1, 12; Williams v. Western Union Tel. Co., 93 N.Y. 162; 4 White on New York Corporations [12th ed.], pp. 34-35). The term "dividend" signifies a distribution of profits or earnings to the shareholders. In its most obvious form it consists of a distribution of cash. It may also be in shares of the corporation. When in this form it is accomplished by segregating that part of the earnings it represents. The segregation is accomplished by capitalization. Therein lies the distinction, as found in the cases, between a mere stock split and a stock dividend. The stock dividend evidences that "the company's accumulated profits have been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution in money or kind should opportunity offer" ( Eisner v. Macomber, 252 U.S. 189, 211). A stock split, on the other hand, results from the simple increase in the number of shares without altering surplus or segregating earnings. The distinction has been clearly put in a number of cases and requires no further elaboration here (see Matter of Davis, 11 Misc.2d 372; Matter of Horrmann, 3 A.D.2d 5, 7; Matter of Sanford, 4 Misc.2d 487, 495).
It is the almost exceptionless holding of the later cases on this subject that the distribution of additional stock to shareholders in conjunction with the capitalization of earned surplus constitutes a stock dividend. It is established with equal clarity that in apportioning the amount of newly issued shares attributable to the new capital no reference is had to market value — that proportion of the shares whose par or stated value is represented by the new capital constitutes the stock dividend (see e.g., Matter of Horrmann, supra; Matter of Sanford, supra; Matter of Berger [ Bankers Trust Co.], 6 Misc.2d 468; Matter of Thoms, 3 Misc.2d 784; Matter of Norton, 129 Misc. 875; Matter of Strong, 198 Misc. 7, affd. 277 App. Div. 1157).
Respondent correctly points out that the only inconsistencies in these recent decisions pertain to questions not here involved. Thus it has been held by some courts that unless earnings be capitalized simultaneously with the issue of the new stock there is no stock dividend ( Matter of Strong, supra; Matter of Lindsay, 11 Misc.2d 374; cf. Matter of Berger [ Bankers Trust Co.], supra) and some have distinguished situations where the dividend is partially from capital surplus instead of wholly out of earnings (see Matter of Payne, 11 Misc.2d 367, mod. 4 A.D.2d 937). Here, however, the transfer of capital supporting the issuance was made entirely from earnings and simultaneously with the new issue.
As has been said by another court in relation to the very distribution by General Electric now before us: "From the foregoing and the wealth of authoritative decisions cited it is readily seen that it (has) been uniformly held that a declaration of dividend such as was made by the General Electric [Company] can only be construed and determined to be a stock dividend." ( Matter of Sanford, 4 Misc.2d 487, 496, supra.)
The cases cited by appellants which deal with the Osborne rule ( Matter of Osborne, 209 N.Y. 450) and what preceded and followed it, are not persuasive of any other conclusion and for that reason are not relied upon or treated in any of the cases above cited. Nothing in appellants' cases differs with the traditional definition of "stock dividend" and in fact some of them serve as further evidence that the definition as applied below was also the judicial sense of that term at the time of the deed's execution. Thus, for example, the Osborne case itself dealt with a 2 for 1 distribution of stock accompanied by a transfer of surplus. This distribution was treated and described throughout that opinion as a stock dividend. Indeed, the rule there propounded assumed the existence of a stock dividend and held merely that, unless the trustor otherwise provided, that part of a stock dividend which represented earnings accumulated before the creation of the trust should be retained as part of principal and that part representing earnings after the creation of the trust be awarded to income beneficiaries. That rule was subsequently modified by section 17-a of the Personal Property Law which provides for the treatment of stock dividends where no express provision is made by the trustor. In the present case express provision has been made rendering this section inapposite. The problem here presented requires only a definition of the term stock dividends as used in the deed. That definition, we have seen, appears with unmistakable clarity in the decisions.
Having ascertained the meaning of "stock dividends" as existent at the time of its selection by the settlor we are obliged to apply it here. What appellants argue, in effect, is that we should now alter the traditional meaning of the term to comport with the definitions used today by the New York Stock Exchange and some accountants. These definitions would limit the term "stock dividend" to include only those shares distributed as dividends and simultaneously capitalized by the corporation at or about its fair market value. In this way, it is hoped, situations like the present one where the corpus of the trust is substantially decreased by distribution of the stock dividend to other than the principal may be avoided. But this approach, it appears to us, overlooks the basic principle ruling our inquiry and that is that the settlor's intent as manifested in his language be effectuated. What appellants suggest actually presumes — without warrant — an intention on the part of the settlor and then seeks to effect it by applying to the language he used a new definition. Thus it is presumed that the settlor would not have desired the impairment of the trust corpora in favor of the residuary legatee. But no such intent appears from the creative instrument. All we have is the language he employed. Examining that language and the sense in which it was used when the deed was executed we are bound to conclude that all stock dividends, as then and now understood, were to be distributed to the legatee. The consequences of that policy are deemed to have been considered and intended by the settlor.
Perhaps the definitions suggested by appellants and the amici curiae more nearly comport with the meaning of stock dividends and stock splits as understood in the modern communities of economics and finance and should be altered. However, that function is properly for the Legislature alone. A judicial change in these definitions now, chancing the frustration of the intent of many settlors and testators who have no doubt relied upon what has heretofore been held to be their meaning, seems to us unwarranted.
The order of the Appellate Division should be affirmed, with costs to all parties appearing separately and filing separate briefs payable out of the trusts.
There is no token of an intention in this 1918 deed of trust that its principal should be depleted by the split-up of the stock of the General Electric Company in 1954. In directing that stock dividends should be treated as income, one would not readily assume that he intended corporate action to be regarded as payment of a stock dividend which is not designated as such in the resolutions of the corporation, and which is recognized as a split-up under the rules of the New York Stock Exchange and, insofar as appears, in the eyes of the entire financial community. It is characterized as a stock dividend only by what seems to me to be an outworn legal fiction. Time was when the capitalized value of shares of stock bore some relation to the market value, and when the earnings of corporations were accustomed to be almost wholly distributed to shareholders, sooner or later, in current cash dividends or in liquidation. Today the productive facilities of corporations are paid for in large part from earnings which have not been and probably never will be distributed to stockholders. Cases are cited such as Williams v. Western Union Tel. Co. ( 93 N.Y. 162); Matter of Osborne ( 209 N.Y. 450); Equitable Trust Co. v. Prentice ( 250 N.Y. 1) as creating an inflexible definition of a stock dividend. Under every possible circumstance it is said that the distribution to stockholders pro rata of shares of trusteed stock must be classified as a stock dividend where simultaneously there has been a transfer of earned surplus to capital. The stockholders' interest in the corporation would be affected in the identical manner (without any distribution of stock) by the transfer of earned surplus to capital, but that would not constitute a stock dividend ( People ex rel. Adams Elec. Light. Co. v. Graves, 272 N.Y. 77). A stock dividend has been held not to occur if a transfer to capital is made but not simultaneously with the distribution of the additional shares ( Matter of Strong, 198 Misc. 7, affd. 277 App. Div. 1157). That illustrates how little substance remains in this definition. The only merit which is left in this rule is that it is precise, but the courts have found it increasingly artificial and have had to restrict its application (cf. Matter of Strong, supra). The law cannot lead an existence of its own apart from the facts of life which give it birth.
However it may have been when capitalization of shares bore some relation to their value, the criterion is now the intention of the corporation, manifested by what it did, in the light of the customs and understanding of the financial community which is the field to which this controversy pertains. The rules of the New York Stock Exchange indicate the commonly accepted meaning and effect of transactions of this nature. It is significant that stock dividends are not allowed to be listed on the Exchange or recognized as such unless there is transferred from earned surplus to the permanent capitalization of the company an amount equal to the fair value of such shares. In the instant case, more than half of the shares of the General Electric Company held by this trust must be distributed as income if this is to be classified as a stock dividend within the meaning of the deed of trust. The transfer to capital here does not remotely approximate the market value of half of the then outstanding General Electric shares. The transaction was treated as a split-up not only by the Stock Exchange but by all of the financial journals and services which have been called to our attention. It appears to have been regarded as a stock dividend nowhere except in court. The New York University Law Review well comments (Vol. 32, pp. 878, 882-884):
"Of course, if the settlor has clearly manifested his intent that large share distributions such as the 1954 General Electric transaction should be allocated elsewhere than to principal, this intent should be honored. However, it is suggested that in those cases wherein there is a reasonable degree of doubt as to the settlor's intent courts should not automatically conclude that the settlor intended that large share distributions, such as that in the Fosdick case, which could be described as a stock split-up effected in the form of a stock dividend, be directed away from the corpus of the trust. Since stock dividends and stock split-ups, however effected, are in fact distinct entities, courts should not equate them. And because it is unlikely that the settlor thought of stock split-ups, however effected, as being stock dividends, courts should not allocate stock split-ups away from principal unless it is extremely clear that the settlor intended this result.
"In order to avoid this automatic equation the courts must abandon the `transfer of surplus' test as a method of determining whether a given share distribution is a stock dividend and replace it with a test which differentiates between stock dividends and split-ups in whatever form effected. The rules of the American Institute of Accountants and the New York Stock Exchange could provide the basis for such a test. Under these rules, if the corporation's basic motive for issuing new shares is to retain accumulated earnings, the distribution should be considered a stock dividend; but if the corporation's primary purpose is to gain the advantages of a stock split-up, the distribution should be so regarded. The number of shares issued in relation to the number outstanding prior to the distribution is an important factor in determining the corporation's purpose, since usually only a distribution consisting of 20 per cent to 25 per cent or more of the number of shares previously outstanding will lower the market price and thereby accomplish the purposes of a stock split-up. Though the corporation's representations to its shareholders should be one of the principal indicia as to the corporation's purpose in distributing new shares, the issuance should not be considered a stock dividend unless it is so small in relation to the shares previously outstanding that it could not reasonably be expected to have an appreciable depressive effect upon the market price, and unless the new shares are capitalized out of earned surplus at the fair value of the shares. Under such a rigorous test share distributions qualifying as stock dividends could be awarded elsewhere than to principal without eroding the interests of remaindermen, since stock dividends as defined by this test do not affect share market price and their allocation away from principal would not decrease the market value of the trust corpus."
Citing American Institute of Accountants, Accounting Research Bulletin No. 43 (1953).
The order appealed from should be reversed and no part of the General Electric stock issue of 1954 should be held to be a stock dividend within the meaning of the 1918 Wood Fosdick deed of trust. Under no circumstance should such shares in the Wood Fosdick trust be held to constitute a stock dividend, in excess of the proportionate number which the earnings capitalized by the corporation would at that time have bought in the market.
Chief Judge CONWAY and Judges DESMOND, DYE and FROESSEL concur with Judge BURKE; Judge FULD concurs in result only; Judge VAN VOORHIS dissents in an opinion.
Order affirmed, etc.