Appeals, Nos. 222, 223, and 228, Jan. T., 1958, from decree of Orphans' Court of Philadelphia County, Dec. T., 1957, No. 187 of 1934, in re estate of Edith B. Cunningham, deceased. Decree reversed; reargument refused April 1, 1959.
Samuel W. Morris, for life tenants.
William White, Jr., in propria persona, with him Thomas S. Weary, and Duane, Morris & Heckscher, for trustee ad litem, and Walter M. Burkhardt, for trustee.
Paul Maloney, with him Francis M. Richards, Jr., and Pepper, Bodine, Frick, Scheetz & Hamilton, for interested persons, under Rule 46.
Ella Graubart, with her Patterson, Crawford, Arensberg & Dunn, for interested person, under Rule 46.
Before Jones, C.j., Bell, Musmanno, Arnold, Jones and Cohen, JJ.
OPINION BY MR. JUSTICE BENJAMIN R. JONES
These appeals involve a reexamination of the century-old "Pennsylvania Rule of Apportionment" with particular reference to its application to certain stock distributions made to a trustee*fn1 by the General Electric Company and the Gulf Oil Corporation.
Edith B. Cunningham died testate, October 11, 1933. By will she created a trust of her residuary estate and appointed as trustee the Fidelity-Philadelphia Trust Company. Under this trust two-thirds of the income is payable to testatrix' son, John B. Cunningham, for life and, upon his death, two-thirds of the principal is to be paid to his issue him surviving in equal shares per stirpes; one-third of the income is payable to John B. Cunningham's daughter, Mary E. Cunningham, for life and, upon her death, one-third of the principal is to be paid to her issue her surviving in equal shares per stirpes. Both the life tenants are presently alive. Mary E. Cunningham, unmarried, is the only living issue of John B. Cunningham. The trust further provides that, if John B. Cunningham should die without issue him surviving, the income is payable to certain named brothers and sisters of testatrix during their lives, and, upon the death of the survivor of them, the principal is to be paid in three equal shares, with stipulations as to its use, to the University of Pennsylvania, The American Oncologic Hospital of the City of Philadelphia and the Board of National Missions of the Presbyterian Church, U.S.A. All testatrix' named brothers and sisters are now dead.
The trustee filed its third account in order that the Orphans' Court of Philadelphia could pass upon various questions relating to the possible apportionment to the income beneficiaries of gains on the sale of certain securities and on stock distributions received by the trustee from certain corporations.
The questions now presented relate exclusively to the trustee-purchased common stock of the General Electric Company and the Gulf Oil Corporation, both of which corporations have distributed additional stock to their stockholders, including the trustee. These questions are: (1) are these stock distributions subject to apportionment between principal and income to any extent? (2) if so, how should such apportionment be effected? The court below*fn2 decided that these stock distributions were subject to apportionment in a manner more fully described herein. These appeals ensued.
A brief recitation of the factual background of each stock distribution is requisite to an understanding of the problem.
On two occasions*fn3 during the term of the trust the trustee purchased a total of 150 shares of the no par common stock of this company. The aggregate cost was $6,935.57, and the aggregate book value as of the purchase dates was $2,403.50. In 1954 the corporation "changed and converted" its common stock by exchanging the old no par value stock which had a stated value of $6.25 per share for common stock having a par value
of $5.00 per share and issuing three new shares in exchange for each old share, thus increasing the trust's holdings from 150 to 450 shares. To effect this distribution required $15.00 in the capital stock account for the three new shares issued (the difference between the par value of the three new shares [$15.00] and the stated value of the old share [$6.25] being $8.75). The new par value was arrived at by two corporate steps: (1) a "write-down" of the stated value of each old share from $6.25 to $5.00, thus making $1.25 of capital available for the "additional" new shares and (2) by transferring the balance required - $8.75 - from "reinvested earnings" (earned surplus) to the capital stock account.
The court below held this "change and conversion" constituted an apportionable event and that 87 1/2% of the "additional new shares" - i.e. the ratio of the amount transferred from "reinvested earnings" to the capital stock account to the adjusted amount of capital realized from both the transfer and "write-down" - was subject to apportionment.
On two occasions*fn4 the trustee purchased a total of 125 shares of the common stock of this corporation, each share having a par value of $25.00. The total cost was $8,736.50 and the aggregate book value as of the purchase dates was $8,997.96. In 1951 the Gulf Oil Corporation authorized the distribution - which it termed a dividend - to its shareholders of one additional share of the common stock of the corporation for each share of its outstanding stock, thus increasing the trust's holdings from 125 to 250 shares. To provide the new par value [$25.00] of the additional share the corporation transferred upon its books $18.549 per
share from earned surplus to the capital stock account and $6.451 per share from paid-in surplus to the capital stock account.
The court below held that, inasmuch as the corporation had transferred on its books from earned surplus to capital stock account approximately 75% of the par value of the new shares, therefore approximately 75% of the new shares received by the trustee was subject to apportionment.
Atlhough General Electric refers to the distribution as a "change and conversion", while Gulf Oil refers to it as a "stock dividend", it is important to note that both transactions were essentially the same in that the par value of the new stock issued was in part supplied by a transfer of earnings to the capital stock account. In both instances, the life tenants rely upon this capitalization and alleged removal of earnings as a source of future dividend payments as justification for an apportionment. This fact was recognized by all the judges of the Orphans' Court of Philadelphia County and we believe by all counsel, all of whom agreed on the facts although differing as to the results which legally flowed therefrom.
Our initial inquiry must be to determine whether these stock distributions constitute events or occasions which, under the "Pennsylvania Rule of Apportionment", require an apportionment of such stock between the life tenants and the remaindermen. The basis of the ruling in the court below was that whenever corporate earnings are capitalized to support the issuance of new shares of stock, whether such shares be issued in exchange for outstanding shares, or as a dividend on outstanding shares, an apportionment must be made.
This inquiry begins with the recognition that the "Pennsylvania Rule of Apportionment" has been abrogated by the Uniform Principal and Income Act of
May 3, 1945,*fn5 subsequently repealed but substantially re-enacted by the Principal and Income Act of July 3, 1947,*fn6 as to all trusts created subsequent to the dates of such legislation. The Rule's application is now limited to trusts created before the effective dates of such statutes: Crawford Estate, 362 Pa. 458, 67 A.2d 124; Warden Trust, 382 Pa. 311, 115 A.2d 159; Steele Estate, 377 Pa. 250, 103 A.2d 409; Pew Trust, 362 Pa. 468, 67 A.2d 129; 99 U.Pa.L.Rev. 864, 865. In view of this legislative declaration of a public policy contra the Rule shall we, as to trusts created prior to such legislation, extend the Rule beyond the point it had reached when such legislation became effective?*fn7 Shall that which had not been judicially determined to be an occasion or event for apportionment be now held such occasion or event, or shall the application of the old Rule be restricted to only those situations judicially recognized as apportionable events or occasions prior to the legislative abrogation of the Rule?*fn8
An examination of all the decisions of this Court on the subject of apportionment indicates that the Rule was applied and apportionment decreed only in the following situations: "(1) the distribution by the corporation of an extraordinary cash or stock dividend, or (2) the liquidation of the corporation, or (3) a sale of the stock by the trustees, or (4) the issuance of stock rights [citing cases].": Jones Estate, 377 Pa. 473, 476, 105 A.2d 353, 354. In Buist's Estate, 297 Pa. 537, 147 A. 606, we said: "The life tenant is not entitled to
any division until (1) the increased value is declared as a cash dividend, or (2) distributed in the form of a stock dividend, or (3) the affairs of the [corporation] are wound up so that assets are distributed to those entitled to receive them, or (4) there is a sale of this stock so that the connection of shareholder is entirely severed".*fn9 See also: Crawford Estate, 362 Pa. 458, 461, supra. In no instance has this Court expressly restricted the Rule's application to these specific situations. However, in point of fact, we have never applied the Rule to other than the above enumerated situations. Moreover, we have expressly held that a merger even though it involves a capitalization of earnings and the issuance of new and different par value shares was not an apportionable event: Jones Estate, 377 Pa. 473, 105 A.2d 353. The instant stock distributions present a situation of first impression in this Court.
The auditing judge found the existence of an apportionable event by concluding that when this Court said that a "stock dividend" constituted an "apportionable event", we meant that "when new stock is issued to existing stockholders and the new stock is supported by a capitalization of earnings, that to the extent of such capitalization of earnings, there is an apportionable event". The Court en banc regarded the stock distribution "in the nature of stock dividends" because earnings had been capitalized and held that "an apportionment is to be made whenever, independent of a corporate merger, earnings or earned surplus are capitalized to support, in whole or in part, the issuance of new shares ..." The court below concluded the Rule's application to the instant stock distributions did not extend the Rule since the transactions could be considered "stock dividend" events.
The basic question is whether an apportionment must be made whenever corporate earnings are capitalized to support the issuance of new shares.
The rationale of the Pennsylvania Rule from its very inception (Earp's Appeal, 28 Pa. 368, 374) has been that a life tenant should not be deprived of earnings which were accumulated since his ownership merely because the corporation decided to declare them in some form other than cash. The logical and essential fairness of apportioning a stock dividend or stock rights which represent accumulated earnings is readily apparent and sustainable. Furthermore, it is entirely consistent to hold that an apportionable event takes place when the stock is sold or the corporation liquidated because such events represent the only and last opportunity for a life tenant to share in any corporate earnings accumulated since creation of the trust. To hold, however, that any capitalization of corporate earnings followed by a stock issuance or stock exchange is an event requiring an apportionment marks a far departure from the original concept which gave birth to the Rule.
To warrant an apportionment it must be shown that there are corporate earnings (since acquisition of the stock) plus an apportionable event. We have treated as apportionable only the following events: the liquidation of the corporation,*fn10 the distribution of a stock dividend,*fn11 the distribution of an extraordinary cash or scrip dividend,*fn12 sale of the stock itself,*fn13 the sale
or the exercise of rights to subscribe to stock*fn14, and the distribution of extraordinary stock dividends even though such dividends are paid in stock of another corporation.*fn15
In Jones Estate, 377 Pa. 473, 105 A.2d 353, we were presented with the problem of whether an apportionable event arose from the merger of the Union Trust Company of Pittsburgh and the Mellon National Bank and Trust Company plus the concomitant capitalization of over $58,000,000 of earned surplus. Prior to that merger the Union Trust Company had a capital stock account of $1,500,000 and an earned surplus of $108,500,000 and the Mellon Bank had a capital stock account of $7,500,000 and an earned surplus of $40,000,000. To accomplish the merger the capital stock account of the new corporation was increased to $60,100,000 from $1,550,000 and it became necessary to transfer from earned surplus to the capital stock account $58,550,000. For each share of stock held the Union Trust Company stockholders received 8 shares of stock of the new corporation and the stock of the Mellon National Bank and Trust Company held by Union Trust Company was cancelled. The earnings capitalized were less than the earnings accumulated by the Union Trust Company between the date of decedent's death and the merger date.Our denial of the occurrence of an apportionable event was not based simply on the existence of a merger as the court below indicated. Appellant's argument in Jones Estate, supra, was exactly the same as the position taken by the Orphans' Court in the instant case, namely that "the true test of whether an apportionable event occurs in a given situation is whether the transaction results in the capitalization
of any earnings in one form or another. If such is the result, there must be an apportionment". We rejected this contention and in our determination that no apportionable event had occurred we said: "While there was no capitalization of surplus ... in that merger [Buist's Estate, 297 Pa. 537] that fact cannot change the principle there established". (p. 478).
Present day economic conditions, particularly in the corporate field, present a drastic contrast to the economic conditions in existence at the inception of and during the formative years of the Rule, and corporate practices plus multiplication and extension of taxes has made the application of the Rule even more difficult and often unworkable. The complexities, the uncertainties, and the difficulties which are inherent in the application and administration of the Rule have too often in these modern times created confusion, injustices and glaring inconsistencies. The essential fairness and equity of the Pennsylvania Rule was beyond question.*fn16 The basis for its rejection and abandonment by legislation is the fact that changes in corporate practice have, in many instances, rendered unworkable the Rule. In recent years the ingenuity of corporate management, seeking to achieve various ends such as broadening or enhancing the market for its stock, effect tax savings, etc., has produced a complexity of corporate transactions which involve the transfer on corporate books of earnings, earned surplus, etc., from one account to another. Earnings, under modern corporate practice, no longer retain the simplicity of meaning of the earnings considered by this Court in Earp's Appeal, supra, and other decisions.*fn17
The general rule in a corporation-shareholder relationship was well expressed in Green et al. v. Philadelphia Inquirer Company et al., 329 Pa. 169, 175, 196 A. 32: "Stockholders are not entitled to the earnings as such of a corporation. A corporation is an entity separate and distinct from its stockholders and a dividend declaration is necessary to create in the stockholder any ownership or other property right in the earnings. Where the owner of corporate stock dies leaving a will whereunder the stock is given to one person for life, with remainder to another person or persons, he does not thereby create any larger property rights as a stockholder in any of his beneficiaries than he himself had". The Rule is an exception to this general rule in that the stockholder is considered to have an ownership in the earnings of the corporation accumulated since the date of the creation of the trust and possession by the stockholder of such earnings awaits only the happening of an apportionable event.*fn18 The sole justification for this exception must rest upon the theory that that which corporate management labels as reinvested earnings, earnings, earned surplus, etc., is actually corporate income which has been earmarked and set aside solely for eventual distribution to the shareholders.
Under modern corporate methods, however, such accounts may be and are set up for various and sundry reasons, for example, to cover future expansion, cost of equipment, future contingencies or reserves for losses in business, etc. and that which is labelled "earnings" may and often does represent items other than income, such as capital gains.
The Rule holds that upon distribution of corporate tenant is entitled to receive the earned net income of a corporation which has accumulated since the stock was acquired, except where it is necessary to preserve the intact value of the principal. The Rule's application requires that the fiduciary, upon the happening of an apportionable event, determine the source from which distribution was made, whether such source consists of actual earnings or profits of the corporation earmarked solely for distribution to stockholders and how much of said earnings or profits have accumulated since the creation of the trust.*fn19
The fiduciary is required in each instance to make a full and complete study and investigation of the entire corporate background and to scrutinize all the corporate transactions at the cost of considerable time and trust money. Even if the fiduciary performs such
a duty its eventual decision too often has to be made on an arbitrary and speculative basis. To include the present type of stock distributions within the orbit of apportionable events would add chaos to an already chaotic condition. Whether we label the new stock distributions as being "in the nature of stock dividends" or not, to hold that they constitute apportionable events would be to extend the Rule's application, an extension clearly without justification in the present state of the law.
This Court, which created the Rule, should be the first to acknowledge its unworkability, inconsistencies and inequities in many instances under modern economic conditions. Parental defense of a child is justified only to the extent that the child's conduct is defensible. The language of the Supreme Court of New Jersey in Estate of Henry Fera, supra, 142 is most apposite: "It is indeed small consolation to either the life cestui or remainderman that equity has apparently been served, if the ultimate result of the endeavor is to substantially reduce the net gain available to the trust estate and the final determination of the respective equities of the parties is founded as much upon speculation and guesswork as it is upon fact. These factors together with the increasing complexity of corporate structures and accounting methods, which progressively makes more difficult and costly an accurate analysis of the past financial history of a corporation, are practical realities that persuade us to reject the [Rule] ..."
The practicalities of the situation, the historical restriction by our Court of the application of the Rule to certain specific situations other than are here present, and the legislative enunciation of a public policy contra the Rule preclude its extension to cover the instant stock distributions.
Decree reversed. Costs on the estate.
CONCURRING AND DISSENTING OPINION BY MR. JUSTICE BELL:
Cunningham Estate and Harvey Estate are test cases, and since on several points they are inextricably intertwined, they will on those points be considered together. They involve the application and clarification of the Pennsylvania equitable doctrine or Rule of Apportionment as applied to stock distributions which were made by several corporations to testamentary trustees which own, respectively, (a) trustee-purchased, and (b) decedent-owned common stock.
More particularly there are two main questions involved: (1) Are any or all of these stock distributions apportionable between life tenant and remaindermen, and (2) if apportionable, what are the correct measuring rods which are applicable?
Since the constantly changing corporate financing, corporate accounting and complex corporate practices have caused such widespread confusion*fn1 in the application of the apportionment rule, it would seem appropriate and wise to analyze and review the basic reason for, and the paramount purpose of The rule, as well as various prior decisions of the Court which are in some respects irreconcilable.
The testamentary trustee purchased 150 shares of the no par common stock of the General Electric Company for an average cost*fn2 of $46.24 per share, or a total of $6935.57. Each share had a "stated value" of $6.25 per share. The book value of each share held in
this trust was $16.02 per share as of the purchase dates, or a total book value of $2,403.50.
In 1954 the company split its stock 3 for 1 in order to broaden the market for its stock, i.e., reduce its market value, in order that it could be purchased by many of its employees and by persons with moderate means, as well as for tax savings and other corporate purposes. In order to accomplish this change, the company "changed and converted" its no par common stock into common stock having a par value of $5 per share, and issued 3 new shares for each old share. This increased the holdings of the Cunningham Trust Estate from 150 shares of no par common to 450 shares of common, having a par value of $5 per share. To validly accomplish this stock split and effect this change, the Company was required by law to amend its charter, and to have a capital equal to $5 per share. The Company effectuated this legally, (1) by a "write-down" of the stated value of each no par share from $6.25 to $5.00, thus making $1.25 of capital available for the two new shares, and (2) by transferring the balance of $8.75 from earned surplus to capital.
It is clear and indisputable that this was not a stock dividend. The orphans' court believed "it was in the nature of a stock dividend". While it was not a simple pure stock split, it was more nearly a stock split than a stock dividend. It was, we repeat, denominated by the Company as a "change and conversion"; and the reasons and purposes were set forth by the Company in its notices to its stockholders. As the Company further stated: "each share of the Company's present Common Stock without par value will automatically be converted*fn3 into three shares of Common Stock having a par value of $5 each". The Company did not
consider or intend this "change and conversion" to be a stock dividend, it was intended to be (a) a change from no par value stock into $5 par value stock, and (b) the conversion of one share into three; and what the Company called it is prima facie evidence of what it was. What an Act, or a contract, or a transaction is termed by the parties is prima facie evidence of what it is, but actualities and realities determine its real nature, and, if inconsistent with nomenclature or labels, prevail. Especially is this so in Equity, because Equity looks through the form and bases its decision upon the substance: McKeown's Estate, 263 Pa. 78, 84, 106 A.2d 189; Nirdlinger's Estate, 290 Pa. 457, 472, 139 A.2d 200; Murray v. Philadelphia, 364 Pa. 157, 71 A.2d 280; Armour & Co. v. Pittsburgh, 363 Pa. 109, 69 A.2d 405. However, in this case the nomenclature fits the facts, and the actualities and realities further demonstrate that this was in reality a stock split, not a stock dividend.
The question then arises: When there is a stock split, as distinguished from a stock dividend, and it is accomplished wholly or, as in this case, in part, by a transfer of money from earned surplus to capital, does this capitalization of earnings require an apportionment between principal and income, and if so, what are the measuring rods to determine how much is allocable to income and how much to principal?
It will, we believe, aid in a solution of these questions and clear up much of the prevailing confusion if we first discuss the origin and the basic reason, object and purpose of the Rule of Apportionment, as well as the difficulty of applying it to modern conditions and various modern complex corporate practices, and then analyze and review many of the cases.
The Pennsylvania Rule of Apportionment had its origin in Earp's Appeal, 28 Pa. 368 (1857). This was
the beginning of the equitable doctrine - which was followed in Pennsylvania for nearly one hundred years until changed by the Legislature in 1945*fn4 - that a life tenant is entitled to the net earnings of a company which are paid out in dividends,*fn5 irrespective of whether the dividend is in cash or in stock or in other forms of property, provided such net earnings had accumulated since the testator's death,*fn6 (or since the acquisition of the stock if trustee-purchased) and provided that the "intact value", i.e., book value, adjusted (whenever necessary) for capital increases and capital losses, was not impaired: Nirdlinger's Estate, 290 Pa. 457; Packer's Estate (No. 1), 291 Pa. 194, 139 A. 867; Waterhouse's Estate, 308 Pa. 422, 162 A. 295; Arrott Estate, 383 Pa. 228, 118 A.2d 187, as to decedent-owned stock; McKeown's Estate, 263 Pa. 78, as to gains on sale of stock.
In Arrott Estate, 383 Pa., supra, the Court said (pages 230, 231): "The basic reason for the rule of equitable apportionment is that a life tenant is entitled to accumulated corporate profits and earnings on stock when it is sold, distributed, stock dividends declared, or the stock with accumulations is otherwise dealt with. The justness of the rule cannot be questioned. The difficulty is in its application.
"In King Estate, 349 Pa. 27, 29, 36 A.2d 504, it was stated by a unanimous court: ... 'In general, it is the rule that on distribution a life tenant is entitled
to receive accumulated profits and earnings except where necessary to preserve the "intact value" of principal. Where there is a stock or cash dividend, a corporate liquidation, a sale or distribution in kind, the life tenant is entitled to such accumulated profits and earnings. It is wholly immaterial in what form such accumulations appear.'"
In other words, the primary and paramount object and purpose of this judicially devised doctrine or rule was to protect a life tenant from being deprived of his equitable share of such dividends*fn7 merely because the dividends were paid in stock or in other kinds of property instead of in cash.
In Packer's Estate (No. 1), 291 Pa. 194, supra, which involved (a) the apportionment of an extraordinary stock dividend and (b) a gain on the sale of securities, the Court said (pages 196, 197): "While Mrs. Thomas, the life tenant, was still alive, an extraordinary stock dividend was declared.The court below awarded to her only so much thereof as in fact represented income. Appellant, the administrator of her estate, claims that, as the market value of the stock was the same after the dividend was declared as it had been before, the whole of it should have been awarded to her, as life tenant. Whether or not this is correct, is the first question raised on the present appeal. After the death of the life tenant, certain of the trust securities were sold, at a price in excess of the appraisement as above made. The court awarded nearly all of the proceeds to the remaindermen. Appellant claims that the whole of it should have been awarded to him, as her administrator; that the profit thus realized was in legal effect income, though it was not earnings of
the corporations accruing after testator's death. Whether or not this is correct, is the only other question raised on the present appeal. The court below was right on both points. ... We there held [in Nirdlinger's Estate, 290 Pa. 457, 139 A. 200] that, in distributing extraordinary stock dividends between a life tenant and the corpus of a trust which holds the original stock upon which the dividend is declared, the former is entitled to receive so many of the new shares as represents the net earnings of the corporation accruing after the trust estate acquired the stock upon which the dividend was declared, for they then represent the accrued income; the latter is entitled to retain all the rest of the stock dividend, for it does not represent income. Neither market value, nor any other value than the actual or intact value [i.e. book value] of the shares, is of any moment in determining how such a distribution is to be made. In making it, there should always be awarded to the corpus of the trust such a number of the shares included in the dividend as, with the shares upon which the dividend was declared, at the actual or intact value [i.e. book value] of the two after the stock dividend is ...