Appeal from the District Court of the United States for the Eastern District of Pennsylvania; J. Cullen Ganey, Judge.
Before BIGGS, CLARK, and JONES, Circuit Judges.
The appellant owns 100 shares of preferred stock of Curtis Publishing Company which he purchased in February, 1940, by paying $4,592 for it. He has sued in a class suit the company, a Pennsylvania corporation, and its directors and prays for an injunction to restrain the company from paying or declaring any dividends on prior preferred stock and from paying interest on or retiring debentures issued by the company pursuant to a plan of reorganization of its capital structure. The appellant also prays that the prior preferred stock and the debentures, as well as the common stock issued under the plan, be adjudged a nullity. In the alternative the appellant prays that the officers of the company pay to the company consideration which the appellant alleges should have been received by it for the prior preferred stock, the debentures and the common stock, including an amount sufficient to protect the rights of the appellant and of all preferred stockholders similarly situated.
Prior to the reorganization of its capital structure and on December 31, 1939, the company had 900,000 shares of preferred stock outstanding of which 736,373 were held by the public and 163,627 shares were owned by the company. The company also had outstanding 1,800,000 shares of common stock without par value. Of these 1,730,101 were held by the public and 69,899 shares were owned by the company. The preferred stock (as distinguished from the prior preferred stock created by the recapitalization) is entitled to a cumulative annual dividend of $7, is entitled to $100 per share on liquidation and is callable at $120 per share. In either event all accumulated, unpaid and accrued dividends must be paid before anything may be paid or distributed to common stockholders. The company's contingent reserve and undivided profit, that is to say earned surplus as of December 31, 1939, was approximately $20,000,000. The company had approximately $8,690,000 in cash and additional quick assets in securities worth approximately $9,201,000. The company has a history of exceedingly successful operation. In the six years from 1927 to 1932 inclusive its net income averaged around $15,000,000 a year, an income rising to $21,500,000 in 1929, though falling to $5,500,000 in 1932. In 1933 net income dropped to $1,300,000. In 1934 it rose again to $5,900,000. In 1935 it was almost that figure. In 1936 it was better than $6,200,000. In 1937 it dropped to about $4,100,000; in 1938 to about $1,300,000, rising in 1939 approximately to $2,140,000. It should be noted that the lowest net income was received in 1933 and 1938 and that the income earned in the year 1939 was lower than in any other years from 1927 to 1939 inclusive save only 1933 and 1938.
No dividends have been paid on the common stock from 1932 on and in 1933 for the first time the full annual dividend of $7 was not paid on the preferred stock.Upon December 31, 1939, the dividend arrearages on the preferred stock aggregated $16.87 1/2 per share and totalled $12,426,000. From 1933 to 1939 inclusive, full dividends not being paid on the preferred stock, the company earned $26,630,000 and paid out by way of dividends approximately $27,337,000 to preferred stockholders. It is plain therefore that the surplus which we have stated existed at the end of 1939 was created from profits earned prior to 1933.
The preferred stock which the appellant holds was issued in 1926 pursuant to a resolution of stockholders passed in December 1925.Part of that resolution (printed on the reverse side of each preferred stock certificate) provides: "So long as any of the Preferred Stock remains outstanding, the Company will not, without the consent of the holders of twothirds of the Preferred Stock outstanding, create any mortgage debt or other obligation which would be entitled to payment out of the assets of the corporation prior to the Preferred Stock, excepting only such obligations as may be incurred in the ordinary and usual course of business, not secured by a lien upon the Company's property, and excepting also purchase money obligations given in connection with the acquisition of new property, nor shall the Company, without such sonsent, ccreate any other issue of stock which shall in any wa impair the rights of the holders of the present issue of Oreferred Stock."
In the latter part of the year 1939 the company, through its directors, proposed to its stockholders a plan for the reorganization of itscapital structure. The plan proposed would have reduced substantially the dividend requirements of the preferred stock and met ith strenuous objection from certain holders of preferred stock including various institutions and trust companies holding stock in fiduciary capacities. Negotiations ensued between the representatives of the company and of these organizations. The plan of reorganization of capital structure which was carried into effect evolved from these negotiations.
The appellant attaches much importance to the fact that directors owned, and own, a very substantial portion of the common stock and that they procured the plan. He also points out that the company spent over $6,000,000 in purchjasing its own shares of stock both common and preferred prior to the recapitalization. From 1933 to 1939 inclusive the company purchased over 60,000 shares of its common stock and over twice this number of shares of preferred stock. The appellant argues that the recapitalization was for the benefit of the common stockholders who were the management and that so much preferred stock ws purchased (and cancelled under the plan) to increase the interest of the common stockholders in the management. We shall deal with these contentions more specifically at a later point in this opinion.
The plan of reorganization which was put into effect is a comparatively simple one. For each share of preferred stock surrendered, the company geve in exchange a new fifteen year 3% debenture in face amount of $10, one share of new prior preferred stock, and 2 1/2 shares of common stock. The 177,580 shares of preferred stock and 66,959 shares of common sotck owned by the company on April 19, 1940, were cancelled. The new prior preferred stock bears a dividend rate of $4 per share. Of this sum $3 is cumulative and $1 is payable and cumulative only to the extent earned. The new prior preferred stock has equal voting rights share and share alikd with the new common stock. If six ofthe quarterly fixed dividends are omitted for any reason, the prior preferred has the right to elect two directors. The prior preferred and common priority over the preferred and common stock as to dividends and on liquidation and its liquidation value is $65 per share.
It id callable at $75 per share.
The fifteen year debentures are callable at ht option of the company on thirty days' notice at a price equal to their face value and accrued interest. The plan provides for the creation of asinking fund amounting to $250,000 per annum to retire the debentures. So long as any debentures are outstanding the company cannot mortgage or pledge any of its assets without consent of the holders of twothirds of the outstanding debentures except by way of purchase money obligations or in renewal of previously secured obligations.
The plan of recapitalization as submitted to stockholders contains a statement iof why recapitalization is desirable. It was pointed out that the dividend arrearages on the preferred stock were substantial, amounting to over $19 a share and totalling nearly $14,000,000 as of April 1, 1940. The discussion of the plan submitted to stockholders stated that it was to the best interest of the company and its "owner-stockholders that interest and cumulative dividend needs be kept within the Company'a ability to earn under business conditions as they now exist.", and " * * * there is every reasonable expectation that the company can make uninterrupted regular dividend payments on the new Prior Preferred Stock, and it is hoped that this stock will be considered a sound investment. The distribution of Common Stock to present Preferred Stockholders who exchange will give them a chance to participate in any future prosperity."
The stated capital of the company, which was $30,000,000, was restated at $22,775,800, the difference being created by the transfer of $7,224,200 to surplus. As a matter of bookkeeping the debentures were charged against this item as they were issued. The cost of the 177,580 shares of it preferred stock and 66,959 shares of its common stock owned by the company and cancelled was charged against surplus. Naturally, the issuance of the prior preferred stock in return for the preferred stock reduced the authorized amount of preferred ...