Guttmann v. Illinois Central R. Co
189 F.2d 927, 1951 U.S. App. LEXIS 3244, 27 A.L.R. 2d 1066 (1951)
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Rule of Law:
If a corporation's board of directors, in a valid exercise of its business judgment, withholds dividends on non-cumulative preferred stock for a given year, the stockholders' right to that dividend is extinguished. The board has neither the power nor the discretion to pay it in a subsequent year.
Facts:
- A plaintiff held shares of non-cumulative preferred stock in an Illinois corporation.
- From 1937 through 1947, the corporation's board of directors exercised its discretion and chose not to declare dividends on the non-cumulative preferred stock.
- During several of those years, particularly from 1942 to 1947, the corporation had net earnings that were sufficient to pay such dividends.
- The directors retained these earnings for various corporate purposes, adopting what the court described as a 'reasonable attitude of reluctant but contingent pessimism about the future.'
- In 1950, the board of directors declared and paid a dividend on the company's common stock.
- The board did not declare any 'arrears' or back-payments on the non-cumulative preferred stock for the years in which dividends had been earned but not declared.
Procedural Posture:
- A holder of non-cumulative preferred stock (plaintiff) sued the corporation in a federal trial court.
- The plaintiff sought an injunction to prevent the corporation from paying dividends on its common stock until it first paid the undeclared dividends from past profitable years on the preferred stock.
- The trial court found that the directors had acted within their discretion in withholding the preferred dividends and ruled in favor of the corporation.
- The plaintiff (appellant) appealed the trial court's decision to the United States Court of Appeals.
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Issue:
Do non-cumulative preferred stockholders retain a right to receive dividends from prior years in which earnings were available but dividends were justifiably not declared, before any dividends are paid on common stock?
Opinions:
Majority - Frank, Circuit Judge
No. When a corporation's board of directors justifiably applies profits to a corporate purpose instead of declaring a dividend on non-cumulative preferred stock within a given year, the stockholders' claim for a dividend for that year is permanently lost. The directors subsequently have no discretion to pay these 'arrears' and may proceed to declare dividends on common stock. The court is guided by the Supreme Court's precedent in Wabash Railway Co. v. Barclay, which held that if profits are justifiably used for corporate purposes and no dividend is declared within the year, 'the claim for that year is gone and cannot be asserted at a later date.' The court rejected the plaintiff's attempt to limit this rule only to instances where earnings were spent on tangible capital improvements, finding no rational difference between retaining earnings for that purpose versus any other legitimate corporate need. The term 'non-cumulative' is to be interpreted literally; the contract did not create a contingent right to arrears, and courts should not intervene to rewrite contracts freely made by competent adults.
Analysis:
This decision solidifies the strict interpretation of 'non-cumulative' preferred stock, often summarized as the 'Wabash rule' or 'discretionary dividend' theory. It clarifies that the specific reason for retaining earnings is irrelevant, so long as the board's decision was a valid exercise of business judgment. This ruling provides corporate directors with significant discretion and puts investors on notice that their dividend rights on such stock are highly contingent and offer minimal protection compared to cumulative preferred stock or alternative legal theories like the 'dividend credit' rule followed in some other jurisdictions.
