CULLEN, Commissioner. In an action against a representative group of its preferred shareholders, and a representative group of its common shareholders, Louisville Transit Co. and its board of directors sought a declaration as to the right of the company to pay dividends out of a surplus that was created upon the organization of the company. The circuit court held that (1) dividends accrued on the preferred stock as of October 1, 1951, may be paid out of the surplus to the extent the earnings of the company since its organization were insufficient for the purpose; (2) dividends accruing on the preferred stock subsequent to October 1, 1951, may in the future be paid out of the surplus to the extent that the surplus is not needed in the conduct of the company's business and to the extent that the earnings of the company are insufficient for the purpose, and such dividends may be paid without paying any dividend on the common stock; and (3) dividends on the common stock may be paid out of the surplus, to the extent that the surplus is not needed in the conduct of the company's business and to the extent that the earnings of the company are insufficient for the purpose, but that such dividends on the common stock may not be paid out of the surplus unless all dividends accumulated on the preferred stock to the most recent quarterly dividend date have been paid, or declared and the payment adequately provided for; however, when the dividends on the preferred stock have been so paid or provided for, dividends on the common stock may be paid out of the surplus without regard to the amount paid on the preferred stock.
The preferred shareholders and the common shareholders have appealed from the judgment. The preferred shareholders contend that dividends may be paid on the common stock, out of the surplus, only to the extent that the surplus exceeds the total par value of all the preferred stock. The common shareholders contend that any payment of dividends out of the surplus must be on an equitable basis, in proportion to the respective holdings of common and preferred stock, and that if any dividend is paid out of the surplus on the preferred stock, a dividend also must be paid on the common stock. Each class of stock also makes a mild claim to a proportionate preference over the other class in the payment of dividends out of the surplus.
A brief statement of the history of Louisville Transit Co. is necessary to an understanding of the issues in the action.
Louisville Transit Co. is a new Kentucky corporation that grew out of a consolidation of The Louisville Railway Company and the Capital Transit Company, both of which were Kentucky corporations. The new corporation came into existence on May 7, 1951. The consolidation was approved in Donohue v. Heuser, Ky., 239 S.W.2d 238.
Immediately prior to the consolidation, The Louisville Railway Company had outstanding, 32,954 shares of preferred stock, with a par value of $100 per share. The stock had a five percent per annum dividend preference, payable 'out of the net earnings of the company,' and the dividends were cumulative. There was no right of preference on dissolution. No dividends had been paid since 1930, and the arrearage of cumulative dividends amounted to $100 per share. There were 80,942 shares of common stock, with a par value of $100 per share, on which no dividends had been paid since 1930.
In 1941, the railway company had created a capital deficit of almost $9 million by reducing the book value of its operating properties, because of obsolescence, and by writing off abandoned property. Earnings and profits subsequent to 1941, in the amount of almost $4 million, had reduced the deficit so that at the time of consolidation the deficit was $4,890,969.
Immediately prior to the consolidation, Capital Transit Company had outstanding, 50 shares of common stock with a par value of $100 per share, of which 40 shares were owned by The Louisville Railway Company. Capital Transit Company had a surplus of $8,936.
In the consolidation, each share of preferred stock of The Louisville Railway Company (having a par value of $100 and a dividend arrearage of $100) was exchanged for $2.50 in cash and one share of preferred stock of Louisville Transit Co., with a par value of $80. Each share of common stock of the railway company (having a par value of $100), was exchanged for one share of common stock of Louisville Transit Co., with a par value of $10. Each publicly-owned share of common stock of Capital Transit Company (having a par value of $100) was exchanged for ten shares of common stock of Louisville Transit Co.
As a result of the reduction of capital stock accomplished in the consolidation, Louisville Transit Co. came into existence with a surplus of $2,950,442.55. That is the surplus which is involved in this action.
The preferred stock in Louisville Transit Co. is entitled to a five percent annual dividend, payable quarterly, 'out of funds legally available for the payment of dividends,' and cumulative after April 1, 1950, in preference to dividends on the common stock. The preferred stock also is entitled to a preference on dissolution, in an amount equal to all accrued, unpaid dividends, and an amount equal to twice the amount per share paid to the common shareholders, not to exceed a maximum of $80 per share. The preferred stock is redeemable at par plus accrued, unpaid dividends.
Between the time of organization of Louisville Transit Co. and the time of bringing the action, the company realized earnings and profits in the amount of $128,997. The accrued dividends on the preferred stock amounted to $197,724. Thus, the basis for an actual controversy existed as to the right to pay, out of the surplus, the amount by which the earnings were insufficient to meet the accrued dividends.
It is alleged in the petition, and not denied in the answer, that at the present time, the portion of the surplus proposed to be distributed in dividends is not needed in the conduct of the company's business.
Reaching now the issues raised on the appeal, it appears at the outset that all parties agree that the surplus is available for distribution among the stockholders; the only controversy being as to respective rights of the preferred and the common shareholders in such distribution. The company and its board of directors contend that the surplus is available for the payment of dividends the same as if it had been accrued by earnings of the company since its organization. The preferred stockholders maintain that the surplus is a 'paid-in' surplus and that by reason of their rights to preference on dissolution, they are entitled to have set aside and preserved, before the payment of any dividends on the common stock, an amount equal to the total par value of all the preferred stock. The common stockholders take the position that the surplus is distributable, not in the form of dividends, but in the way of a distribution of capital, and that the distribution must be on an equitable basis, either in proportion to the respective 'contributions' made by the two classes of stockholders in the exchange of the old stock for the new, or in proportion to the respective holdings of common and preferred stock. However, it appears that the common stockholders are primarily interested in overcoming the contention of the preferred stockholders, and they do not strongly urge any right other than their right to receive a dividend too, if the preferred stockholders are given a dividend.
We have been cited to no authority, and have been unable to find any, on the specific question of the status, and availability for payment of dividends, of a surplus created upon the organization of a consolidated corporation, through a reduction in the capital of the consolidating corporations. However, a closely analogous situation was presented in Haggard v. Lexington Utilities Co., 260 Ky. 261, 84 S.W.2d 84, in which a corporation translated a deficit into a surplus by means of a reduction of its capital stock. In that case the capital of the corporation became impaired by reason of losses on investments. The amount of the impairment was $1,700,000. Subsequently, the corporation reduced its capital stock, as a result of which a surplus was created. Between the time the capital became impaired and the time of the reduction of the stock, the corporation had net earnings of $200,000, ...