Maryland Trust Co. v. National Mechanics Bank

McSherry, C. J., delivered the opinion of the Court. These are appeals from an order passed by Circuit Court No. 2 of Baltimore City on July the thirty-first nineteen hundred and five. By that order certain exceptions filed by the Maryland Trust Company and also by several shareholders of that company against the allowance of a claim preferred by the National Mechanics Bank, of Baltimore, wrere overruled, and tthe Receiver of the Trust Company was ordered to pay the ¡'claim out of any assets of the Trust Company in his hands Rafter the payment in full of the claims of all other creditors of |the Trust Company. From that order both the Maryland Trust Company and the objecting shareholders have appealed.

The questions involved are numerous and important, and the amount of money at stake is large. The record and the briefs are voluminous ; and the cases have been argued with marked ability, and we have given to them a patient; and careful consideration. Before stating or discussing the questions which are before us, a brief outline of the material facts must be given — and this we now proceed to do. By an Act of the General Assembly of Maryland, approved •on March 29th, 1894, being chapter 164 of the Acts of the January Session of that year, the Maryland Trust Company was incorporated..

It was duly organized and began business under and pursuant to its charter. In March, 1901, a merger of the Guardian Trust Company in the Maryland Trust Company was proposed and its accomplishment was undertaken by Mr. John B. Ramsay for a consideration of one hundred thousand dollars to be paid to him by the Maryland Trust Company. ⁶¹¹ The basis upon which the merger was to be effected was the exchange of two shares of Guardian Trust Company stock for one share of Maryland Trust Company stock, that ratio being adopted because it was considered that a share of the last-named company’s stock was worth as much as two shares of the Guardian Trust Company’s stock. In a short while Mr. Ramsay.secured at least sixty per cent of the Guardian Trust Company’s shares for exchange under the merger agreement, and was paid his stipulated fee of one hundred thousand dollars. There were, however, left outstanding quite a number, approximately, four thousand of Guardian Trust shares, the owners whereof seemed indisposed to go into the merger scheme because they believed the value of the Maryland Trust Company shares was not equal to double the value of the Guardian shares; and this belief had its origin in the fact that the market values of the respective shares did not show a ratio of two to one.

A further disturbing element made its appearance on March 2.3rd in the shape of an offer-by Hambleton & Company, published in “The Sun” of that day, to pay one hundred and ten dollars a share for the Guardian Trust stock, provided a majority of the stock of that company was deposited with them by the first of April, 1901. On March 23rd Maryland Trust Company stock was selling at two hundred and five dollars a share, though three days before, it brought two hundred and fourteen dollars per share. The officers of the Maryland Trust Company were anxious to get in all the shares of the Guardian Trust Company, and when this “obstacle” and “hitch in the deal,” occasioned by the want of parity in the market value of the two stocks and the depression in the Maryland shares confronted them, they applied to Mr. Ramsay (whose contract to secure a majority of the Guardian Trust Company’s stock had then been executed and completed) with a view of procuring aid to buy and carry the amount of Maryland Trust stock necessary to overcome the raid being made by Hambleton & Company. “We approached1 Mr. Ramsay on the matter,” so Mr. Scott testified, “and he was perfectly willing to do as we suggested, and, in fact, ⁶¹² thought it a very wise proceeding, but said that he could not lend the Maryland Trust Company enough money to buy the stock, and the obligations would have to be given in somebody else’s name, with the Maryland Trust Company as guarantor.” At that time Mr. Ramsay was, and still is, the president of the National Mechanics Bank, and when the ap- ) plication was made to him to buy and carry the Maryland I Trust Company’s stock, so as, by that means, to raise and j maintain the apparent market price thereof in order thereby to l influence the outstanding holders of the Guardian Trust Com- | pany’s stock to part with their shares on the basis fixed in the '¡merger agreement, he was approached, not individually, but as the representative of a bank and the transactions which immediately ensued brought the Mechanics National Bank into ^ the negotiations for the first time. _ As soon as the proposal j to go upon the stock market and buy up shares of the Maryland j Trust Company for the Maryland Trust Company for the purpose indicated, was suggested to and approved of by Mr. Ramsay, he proceeded to carry out the plan through a broker with whom he had been formerly associated as partner and also through other firms of brokers. As the stock of the Maryland Trust Company was bought, the bills in most instances were made out in the name of the Mechanics Bank as puixhaser and upon presentation of the bills to the bank accompanied by the shares, transferred in blank, they were paid generally, if not invariably, by checks of the bank's cashier, i The shares were treated as cash items until a considerable ■ amount expended in their purchase had accumulated, and then } a receipt, to escape the payment of the revenue tax, subse1 quently changed to a note cif, and signed by, some employee i of the Maryland Trust Company was given to the bank for J that amount, and was guaranteed by the Maryland Trust Com- | pany and the shares of stock so purchased were pledged, at I the market value paid for them, as collateral security.

This * process was repeated and carried on until the bank had paid out for thirteen hundred and eleven shares of the Maryland Trust Company’s stock sums which, with interest added, now ⁶¹³ aggregate two hundred and eighty-five thousand, seven hundred and sixty-three dollars and forty-eight cents. This is the claim Which the bank now seeks to have repaid out of the assets of the Maryland Trust Company in the hands of its receiver. There is no doubt that the trust company was en- j tirely solvent when these transactions took place, but, from] other causes, it was placed in the hands of a receiver in Oc- j tober, 1903. The company itself and its stockholders resist] the payment of this claim upon several grounds, the more important whereof are the only ones we need consider or determine.

The form in which the transactions with the bank were couched excluded, on its face, the theory that the trust company was primarily liable to repay to the bank the sums advanced by the latter for the purchase, in the open market, of the stock of the former; because the receipts later on replaced by the notes given to the bank for the amounts so advanced were the promissory notes, not of the trust company, but of three employees of the trust company, and the liability of that company on those notes was the liability of a guarantor, and therefore purely a secondary obligation. The books of the bank do not show an entry of any kind indicating that the trust company was an original debtor to the bank on account of these advances. The form in which these dealings were thus put was adopted with the distinct and avowed view of avoiding an open and apparent infraction of Sec. 5200 of the Revised Statutes of the United States which prohibits a national bank from lending to any person, company, corporation or firm more than ten per cent of the bank’s capital. But waiving these preliminary objections and treating the trust company as the primary debtor to the bank it is settled by repeated decisions of the Supreme Court that no one except the government itself can take advantage of a violation of Sec. 5200, Union Mining Co. v. Rocky Mt.

Bk., 96 U. S., 640 , and we are then brought to a consideration of the more serious and substantial difficulties which confront the bank in its efforts to get reimbursement for these advances from the assets of the trust company. ⁶¹⁴ The trust company and its stockholders resist the- demand of the bank on the ground that the contract entered into between Mr. Ramsay in behalf of the bank,'and the officers of the trust company, in behalf of that institution, is both illegal and ultra vires, and it is insisted that the contract is illegal and ultra vires, first, because it contemplated and provided for a “rigging” of the stock market; secondly, because the purchase for the trust company of the shares bought pursuant to the terms of the contract withdrew from its creditors and depositors and the remaining shareholders the protection afforded by the double liability imposed upon the owners of its stock by the express provisions of its charter; and illegally reduced the amount of the capital stock; thirdly, because, the executive committee, if it even did direct the officers of the trust company to enter into the contract — which is cjenied — had no power or authority to give such direction; fourthly, because treating the advances as direct loans by the bank to the trust company, the lender made it a part of the contract of lending and borrowing that the money so lent should be used for the illegal purpose of a purchase by the trust company of its own capital stock, and therefore the bank participated in the illegal design and its execution and actually itself applied the money towards the accomplishment of that purpose. Ultra vires and illegality represent totally different ideas. Bissell v. R. R., 22 N. Y. 269 . Ultra vires contracts are strictly speaking, only those which are defective solely because they are beyond the power of the corporation; when they involve some adventure or undertaking not within the scope of the charter, which is the rule of its corporate action.

Leslie v. Lorillard, 110 N. Y. 519 ; S. C. 1, L. R. A. 456. If the contract is illegal as in violation of established principles of public policy, it cañnot, of course,be enforced, 2 Page on Con., sec. 1084, and the like result will follow if the contract is repugnant to the Code. We have had occasion, quite recently, in the case of the Western Maryland Railroad Company v. The Blue Ridge Hotel Company, decided in December, 1905, ante p. 307, to go into a consideration of the doctrine of ⁶¹⁵ vltra vires and to point out in an elaborate land carefully prepared judgment delivered by Judge Pearceí,x the limitations upon and qualifications of that doctrina., as affected by the circumstance that a contract is executory and not an executed one, and we need not now repeat what was there so well and lucidly stated. If the contract we are dealing with in this case is open to the objection of being both ultra vires and illegal the discussion will be greatly abbreviated by omitting all reference to the ultra vires feature as a distinct ground of invalidity, and by confining ourselves to a consideration of the alleged illegality.

The discussion will be shortened by putting aside the mere ultra vires character of the contract, because a contract simply ultra vires is not necessarily unenforceable — it may be enforced under certain conditions — and, hence, before it can be stricken down on that ground alone, all the conditions under which it may be upheld must be eliminated, and to exclude them all would involve a prolonged examination and analysis of numerous facts and a minute application of many legal principles, none of which need be alluded to at all, if the contract is void by reason of its illegality. In the view we take of the case we will not be required to consider separately the first of the four grounds mentioned above, because if the contract upon which the bank relies to support its claim is illegal for or on account of any of the other reasons assigned, it cannot be enforced, and there will be no occasion to discuss the features concerning “rigging the market.” The second and fourth grounds being closely akin and to some extent interwoven with each other, will be treated together. The contract, though heretofore outlined’, must now be somewhat more particularly stated so that the relevancy of the comments which will be made upon it may be apparent. Put in the simplest and plainest form the contract provided, that the bank was to furnish the money necessary to enable the Maryland Trust Company to have its own stock purchased on the Stock Exchange through agents who would not disclose the fact that they were buying for the trust company, in order to create the impression upon the ⁶¹⁶ public and in the minds of the holders of the minority of-the Guardian stock, who had indicated an unwillingness^/fo exchange-their shares for Maryland Trust stock, that there was a demand for the Maryland Trust stoqk in excess of what the real demand was, and thereby to bring the Guardian stockholders in, and to hold the market against the anticipated Hambleton raid.

The further effect of the contract was to reduce, by the number of shares purchased under it, the capital stock of the Maryland Trust Company and to withdraw from its creditors and depositors and the remaining shareholders the protection of the double liability clause of the statute, to the extent of over two hundred and sixty thousand dollars. Can such a contract be enforced? Assuming now that the Maryland Trust Company authorized that contract to be. entered into, is it a legal contract ? Obviously it was, as to part of its subject-matter, a contract to do something which was calculated to mislead the public and especially to induce the minority shareholders of the Guardian Trust Company (who had not gone into the merger because of the inequality in the market value of the shares of the two companies at the ratio of the proposed exchange) to believe that there was a demand for the Maryland Trust stock at a price nearly equal to twice the value of the Guardian stock, whereby those minority shareholders would be influenced, and undoubtedly were prevailed on, to surrender then-shares in exchange for Maryland Trust shares which have now turned out to be much less valuable.

As to the rest of its subject-matter, it was a contract which, in its performance, caused a reduction of the capital stock of the Maryland Trust Company in an illegal way, and destroyed pro tanto the double liability imposed upon the company’s shareholders by the law of the company’s being. In these latter particulars the contract was an illegal one. Whilst the gentlemen who were concerned in this transaction never dreamed for a moment that they were engaged in an undertaking which was unlawful because in the teeth of a general statute, and plainly subversive of a sound and virile ⁶¹⁷ public policy as herein later on pointed out; and whilst a purpose to do wrong was never in the most remote way contemplated by any of them; still men are held by the law, generally to have intended the natural, and always to have intended the necessary, immediate and inevitable consequences of their voluntary acts; and however innocent their motives may have been, they must be treated, when their conduct and contracts are being dealt with in such proceedings as the one before us, precisely as though they designed to accomplish the results which necessarily, immediately and inevitably flowed from what they deliberately did, pursuant to a contract to do the thing so done. A corrupt intent is not necessary. 15 Am. & Eng.

Ency. A, 936. It is common knowledge that fictitious values are given'to investment securities by the method resorted to in this instance, but the prevalence of the method does not sanction its employment nor alter its impropriety, though perhaps it may account for the adoption of such an expedient by persons who would, but for its general use, be the least apt to have recourse to it. “I am quite aware,” said Lindley, L. J., “that what the plaintiff has done is very commonly done; it is done every day. But this is immaterial.” Scott v. Brown, 2 Q. B.

(1892), 724. The discussion which we now approach involves the following inquiries: Was the reduction of the Maryland Trust Company’s capital stock by the purchase for it of its own shares under the contract alluded to lawful; and was the ex-tinguishment by that method of the stockholders liability to the extent of the responsibility represented by the purchased shares, consonant with a sound, healthy, public policy? The Code of Public General Laws in Art. 23, secs. 82 to 87, both inclusive, makes distinct and minute provisions relative to the method to be followed when the amount of the capital stock of a corporation is to be diminished. The fact that the Legislature has prescribed a particular mode' to be pursued for the accomplishment of such a result necessarily excludes the' right to resort to any other or different method.

Those sections enact that public notice published for at least four sue ⁶¹⁸ cessive weeks must be given that a meeting of the shareholders will be held to determine whether the-capital shall be diminished, and that if the shareholders owning at least two-thirds of the whole stock shall at" such meeting decide to reduce the amount of the capital, a certificate in due form shall be made out, sworn to and recorded where the principal office i of the corporation is located. That is the only lawful way in [which the amount of the capital stock could be diminished. Did the purchase by the bank for the trust company of thirteen hundred and eleven shares of the latter’s capital stock constitute an unauthorized — that is, an illegal — reduction of the stock to the extent of the shares so purchased? That inquiry is satisfactorily answered by Mr. Morazvetz, in sec. 112 (2 ed.), of his work on Corporations, in these words: “A purchase by a corporation of shares of its own stock, in effect, amounts to a withdrawal of the shareholder whose shares are purchased, from membership in the company, and a repayment of his proportionate share of the company’s assets.

There is no substitution of membership under these circumstances as in case of a purchase and transfer of shares to a third person, |but the members of the company and the amount of its capital are actually diminished. Whatever a transaction of this character may be called in legal phraseology, it is clear that it really involves an alteration of the company’s constitution, just as the withdrawal of a member of a co-partnership, jvith his proportionate share of the joint funds, involves an alteration of the constitution of a co-partnership. The amount of the company’s assets and the number of its shareholdérs, are diminished; every continuing shareholder is injured by the reduction of the fund contributed for the common venture; and the creditors, who" have trusted the company upon the security of the capital originally subscribed, or who are en- . titled to expect that amount of security, are entitled to complain. It is no answer to say that shares having a market value must be regarded like any other personal property, and that no person is injured if a solvent corporation in good faith purchases shares in itself at their market value, inasmuch as ⁶¹⁹ the shares so purchased are property in the hands of the company, and may at any time be re-sold or sold.

No verbiage can disguise the fact, that a purchase by a corporation of. shares in itself really amounts to a reduction of the company’s I assets, and that the shares purchased do in fact remain extin- ¡ guished, at least until-the re-issue has taken place. The fact that such a transaction may not necessarily be injurious to any person is not a sufficient reason for supporting it. It is contrary to the fundamental agreement of the shareholders, and is condemned by the plainest dictates of sound policy. To allow the directors to exercise such a power would be a fruitful source of unfairness, mismanagement and corruption.

It is for these reasons that a shareholder cannot be allowed to withdraw from the corporation with his proportionate amount of capital, either by a release and cancellation before the shares have beep paid up, or by a purchase of the shares with the company’s funds.” The questions we are now considering have not been directly decided in Maryland and we may, therefore, be justified in citing somewhat at length from adjudications in other jurisdictions on this subject. As some of the cases to which we will allude bear upon the inquiries both as to the effect of a purchase by a corporation of its own stock, and the effect of such a purchase when the stockholder is burdened with a superadded statutory liability, it will b,e appropriate at this point to advert to the status of the Trust Company’s shareholders as l-espects that statutory-liability. By the Act of i8g2, ch. iog, sec. 85L, which related to Safe Deposit, Trust and Guaranty Companies, it was provided that “each stockholder shall be liable to the depositors and creditors of any such corporation for double the amount of stock at the par value held by such stockholder in such corporation.” ■ By the 15th sec. of the charter of the Trust Company, the corporation was made “subject at all times to the provisions of the Act of i8g2, ch. log.” The constitution of the State in Sec. jg, Art. 3, declares that “the General Assembly shall grant no charter for banking purposes, nor renew any bank ⁶²⁰ ing corporation now in existence, except upon the condition that the stockholders shall be liable to the amount of their respective share or shares of stock in such banking institution for all its debts and liabilities. Turning now to the case of Coffin v. Greenless & Ransom Co.., 38 Ohio St. 275 we find an adjudication precisely, in point.

Wé quote somewhat at length because the reasoning seems to be. both cogent and apposite. “The power of a trading corporation,” said the Court, “to traffic in its own stock, where no authority to do so is conferred upon it by the terms of its charter, has been a subject of much discussion in the Courts ; and, the conclusions reached by different Courts, have been conflicting. Of course, cases wherein the power is found to exist by express or implied grant in the charter, furnish no aid in the solution of the question before us ; unless the. claim of the plantiff can be sustained, that such power was conferred on the defendant by section 63 of the Corporation Act of 1852, as amended, which confers on manufacturing corporations the powers enumerated in section 3 of the Act, and, among others the power to acquire and convey at pleasure, all such real and personal estate as may be necessary or convenient to carry into effect the object of the corporation. We think, however, that this claim cannot be maintained. The sole object of the , defendant corporation was ‘for manufacturing purposes;’ and it cannot be said in any just sense, that the power to acquire or , convey its own stock was either necessary or convenient ‘for manufacturing purposes’. “The doctrine that corporations, when not prohibited by their charters, may buy and sell their own stocks, is supported by a line of authorities ; and prominent among them may be mentioned the cases of Dupee v. Boston Water Power Co. 114 Mass. 37 and C. P. & I. R. R. Co. v. Marsailles, 84 Ill. 145 .

But nevertheless we think the decided weight of j authority, both in England and the United States, is against 1 the existence of the power unless conferred by express grant ^ or clear implication. The foundation principle upon which these latter cases rest, is that a corporation possesses no ⁶²¹ power except such as are conferred upon it by its charter either by express grant or necessary implication ; and this principle has been frequently declared by the Supreme Court of this State ; and by no Court more emphatically than by this Court. It is true, however, that in most jurisdictions where the right of the corporation to traffic in its own stock has been denied, an exception to the rule has been admitted to exist, whereby a corporation has been allowed to take its own stock in satisfaction of a debt due to it. This exception is supposed to rest on a necessity which arises in order to avoid loss. * * * * But however that may be, the right of a corporation to traffic in its own stock, at pleasure, appears to us to be inconsistent with the principle of the provisions of the present Constitution.

Article 13, sec. 3, which reads as follows : ‘Dues from corporations shall be secured by such individual liability of stockholders, and other means, as may be prescribed by law; but in all cases each stockholder shall be liable over and above the stock by him or her owned, and any amount unpaid thereon, to a further sum, at least equal in amount to such stock.’ Now, it is just as plain that a business or trading corporation cannot exist without stock and stockholders, as it is that creditors of such corporation are entitled to the security named in the constitution. State, ex. rel. Atty.-Gen. v. Sherman, 22 Ohio, St. 411. . The corporation itself cannot be a stockholder of its own stock within the meaning of the provision of the constitution.

Nobody will deny this proposition. And if a corporation can buy one share of its stock at pleasure, why may it not buy every share? If the right of a corporation to purchase its own stock at pleasure exists and is unlimited, where is the provision intended for the benefit of creditors? This is not the security to which the constitution invites the creditors of a corporation.^ I am aware that the amount of stock required to be issued is not fixed by the constitution or by statute, and also that provision is made by statute for the reduction of the capital stock of corporations; but of these matters creditors are bound .to take notice.

They have a right ⁶²² however to assume that stock once issued, and not called back in the manner provided by law, remains outstanding in the hands of the stockholders liable to respond to creditors to the extent of the individual liability prescribed. In this view it matters not whether the. stock purchased by the corporation that issued it, becomes extinct or is held subject to be re-issued. It is enough to know that the corporation as purchaser of its stock does not afford to creditors the security intended. And surely, if the law forbids the organization of a corporation without stock, because the required security is not furnished, it cannot be that having brought the corporation into existence it invests it with power to assume at pleasure, the identical character or relation to the public, that was an insurmountable objection to the giving of corporate exist- . ence in the first place.^> * * * The general law of the State, of which all persons are presumed to have knowledge, is the source and limit of all its powers and duties; and these cannot be varied either by usage or contract.

The doctrine of estoppel has. no application in the case.” In Crandell v. Lincoln, 42 Conn. 99 , where the capital of a corporation was diminished by the purchase of its own shares, it was held that, “The statute fixing the minimum number of shares and their par value determined as far as practicable the minimum value . of the capital stock, and it was clearly the intention of the Legislature that it should be no less. The number of shares therefore, could not be reduced, and the value of all the shares diihinished, except by legislative authority. If the trustees could purchase stock with the capital of the corporation, they could of their own authority reduce the number of shares and correspondingly diminish the aggregate value of all shares. * * * The statute forbidding the-company to make dividends payable from the stock” (and we have such a statute in Maryland, Code, Art. 23, sec. 75) “and to loan money upon a pledge of its stock, by necessary implication forbids the company from purchasing its own stock. The provision that the company may have a lien upon the stock as security for any debt due from the owner is not in conflict with this ⁶²³ view of the statute.

Such lien does not contemplate that the company may become the owner of the stock. It contemplates rather that the lien shall be enforced, like any other lien, by a sale of the stock, the purchaser being substituted for the delinquent stockholder. “Where it is provided by law that each stockholder, in case of insolvency, shall be liable to contribute a sum equal to the nominal value of his stock, there is an obvious reason why the company cannot become a stockholder. If it may, it withdraws from the fund designated to secure creditors a sum equal to' the nominal value of the stock so owned. *