Northern Central Dividend Cases

Burke, J., delivered the opinion of the Court. The appeals in the above entitled cases were taken from eight decrees dated J anuary 8, 1915. E'our of these decrees were passed by the Circuit Court of Baltimore City, and four by Circuit Court No. 2 of Baltimore City. The appeals involve: First, questions arising between life-tenants and ¹⁹ remaindermen over certain dividends declared by the Northern Central Railway Company; and secondly, questions of apportionment of such dividends between life-tenant an<j, remaindermen as may be determined to be income.

The determination of the questions involved can be • readily reached by the application, to the facts of each particular case, of principles which appear to be well settled in this State. The amounts involved are very large, and the decision which we make on these appeals will be of great importance to Trustees and others holding stock of the Northern Central Railway Company and interested in the dividends which form the subject of this controversy. As the decision of each ease depends upon the same general principles, all the cases will be disposed of in one opinion to be filed in No. 56—the case of Safe Deposit and Trust Company of Baltimore, Trustee, v. Mary V. Miller, et al. A statement of what we regard as the controlling and determining facts upon which the main questions in the ease depend will now be made: The Northern Central Railway Company is a corporation under the laws of Maryland and Pennsylvania, operating a line of railroad from Baltimore, Md., to Sunbury, P'a., with a number of branches, and has for many years been physically connected with the lines of the Pennsylvania Railroad Company. Prior to 1900 the Pennsylvania Railroad and its subsidiaries acquired approximately one-half of the stock of the Northern Central Railway, and in 1906 acquired an actual majority of said stock.

For many years there had been a controversy or difference of opinion between the Pennsylvania Railroad and the minority stockholders of the Northern Central Railway, based upon the contention of the minority stockholders, among others, that too large a proportion of the real earnings of the Northern Central Railway were withheld from dividend distributions, and with the accounting methods or principle by which the earnings of the Northern Central Railway were ascertained. ²⁰ The controversy resulted in 1909 in the appointment of a committee to consider what was described as permanent operating relations between the Pennsylvania Railroad and the Northern Central Railway, and intended to insure to the stockholders a fixed, but larger income return both on account of past and of future earnings. After prolonged negotiations a settlement was reached which provided: First, for a lease s>f the Northern Central Railway to the Pennsylvania Railroad at an annual rent, over and above all costs of operation and maintenance, and available for distribution as dividends to the stockholders of the Northern Central Railway of $2,166,360.00, this amount being an increase over the dividends paid annually for the preceding ten years of $618,-964.00; second, the declaration of a stock dividend of 40%, amounting to $1,134,050.00 and a cash dividend of 10% amounting to $1,934,250.00. At a meeting of the stockholders of the Northern Central Railway held on November 2, 1910, the settlement was approved, and the lease was authorized and the capital stock of the company increased by an amount sufficient to provide for the stock dividend, and the dividends were approved. The resolutions of this meeting recited that the question of the proposed increase of the capital stock of the company of 154,-141 shares of the par value of fifty dollars each, over and above the 368,851 shares of the par value of fifty dollars each, then issued and outstanding, and the issuance thereof having been, pursuant to resolution of the board of directors and after sixty days’ notice given and published as required by law, submitted to the meeting for the consent and authority of the stockholders, it was “Resolved, That the consent and authority of the stockholders of this company be, and they are hereby, giren to the proposed increase of said company’s capital stock of one hundred and fifty-four thousand, seven hundred and forty-one (154,141) shares, of the par value of fifty (50) dollars each, over and above the three hundred and eighty-six thousand, eight hundred ²¹ and fifty-one (386,851) shares, of the par value of fifty (50) dollars each, now issued and outstanding, and the issuance, and disposition of said increase primarily for the purpose mentioned and prescribed in the resolution of the Board of Directors of 14th July, 1910, viz: as and for a stock dividend upon the company’s present outstanding capital stock, representative of and based on expenditures for additions and betterments of the company’s property made from time to time out of its surplus earnings to a larger amount in the aggregate, and which might otherwise have been available for and distributable as dividends among its stockholders, if the Directors had so determined, etc.” The report of the board of directors of the company for the year 1910, reporting the capitalization of the extraordinary expenditures out of income and the extraordinary expenditure fund is here transcribed: “During the year the capital accounts of your company were increased $6,638,155.77, distributed as between Cost of Road, $6,057,252.02, and Cost of Equipment, $580,903.75, representing a portion of expenditures for new construction, equipment and real estate during the ten years ended December 31, 1909, heretofore expended out of surplus income, and which have not been heretofore entered in your capital accounts.

This action was taken to place upon your books the cost of additions and betterments, which were, in the judgment of the Board, properly considered a capital investment, and also, with other changes, to conform to the uniform accounting regulations and new form of General Balance Sheet promulgated by the Interstate Commerce Commission, and the State of Mary-' land.” The controversies between the minority stockholders and the Northern Central Railway Company, above referred to, had been of long standing. The character of the controversy ²² and the consideration for the settlement are shown in the statement of the claim made on behalf of the minority stockholders. In some instances these claims were made as claims of right against the railroad company, whether the lease was made or not, and in part were contingent upon the execution of the lease. The settlement that was made included the execution of the lease, and the issue of the stock dividend as inseparable parts of a single transaction.

The claims made by the stockholders were as follows: 1. That the Northern Central Railway had an earning capacity far in excess of the amount shown by the company’s statements, and in excess of the amount distributed as dividends, and the stockholders were entitled as a matter of right to an increase in the dividend. 2. That this large earning capacity had existed for many years; that a good portion of the earnings of the company had been diverted to capital purposes through the Extraordinary Expenditure Fund, and also through the charge of capital items directly to income or to expense of operation. 3. For distribution of the increase in the sales value of the securities over the book value.

For the distribution of the surplus of the Union Railroad Company. For the increase in the value of the Insurance Fund. By a small minority of the stockholders the validity of the sale to the Pennsylvania Railroad of part of the stock of the Union Railroad was also questioned. The amounts involved in the claims or contentions of the various parties were accurately ascertained by expert examination, but the settlement was not based upon any exact agreement between the parties as to the amounts to> which the’ stockholders might be entitled.

The fluctuating market value of the stock of the Northern Central Railway Company between the years 1900 and 1914 is shown by the following table: ²³ Y ears. Sigh. Low. 1900 ............ 100 82% 1901 ............ 106% 88% 1902 ............ 125% 104 1903 ............ 118 84% 1904 ............ 109% 71 ' 1905 ............ 1103,4 99 1906 ............ 111% 97 1907 ............ 97 78% 1908 ............ 102 80 1909 ............ 121% 100 1910 ............ 132 115 1911 ............ 130% 121 1912 ............ 130 121 1913 ............ 123 106% 1914 ............ 129% 85 Since the payment of the extraordinary dividend and the execution of the loan the value of the stock has varied between $82 and $85 per share. Owing to threatened litigation it was made one of the terms of the agreement between the Northern Central Railway Company and the Pennsylvania Railroad that the latter railroad should not be obliged to execute the lease until so advised by counsel, but that the lease when executed should take effect as of January 1, 1911.

The lease was actually executed on July 29, 1914. About this time there was formally declared and issued the dividends provided for in the settlement between the company and its stockholders, that is to say: Eirst, a stock dividend of 40%; second, a cash dividend of 10%. The aggregate value of these dividends is: Par. Value.

Gash Value. 40%........ $7,734,050.00 $13,147,885.00 10%........ 1,934,250.00 1,934,250.00 There was paid at this time an extraordinary dividend of 8% on the capital stock of the company as increased by the ²⁴ issue of the stock dividend. This latter dividend, while in form a dividend of 8% on the capital stock plus the 40% increase, is in fact a dividend of 28% upon the 40% stock dividend alone, said dividend arising as follows: During .the interval between the authorization and the execution of the lease, that is approximately from January 1, 1911, to' July 1, 1914, the Northern Central Railway was operated as theretofore, without respect to the lease. There was annually paid to the stockholders a dividend of 8% on the original 100%, but not on the 40% increase. The annual rent reserved by the lease, however, exceeded this dividend by the sum of $618,964, or 8% annually upon the amount of the 40% stock dividend.

After the execution of the lease and in the adjustment of the accounts' between the lessor and lessee companies for the period intervening between January 1, 1911, and July 1, 1914, the dividends so paid on the original 100% to the stockholders were treated as if it had been a part of the rent paid by the Pennsylvania Railroad, lessee, to the Northern Central Railway, and distributed by the latter company to its stockholders and as a credit on said rent. This left the lessee in arrears for so much of the rent as was equal to a dividend of 8% on the 40% stock dividend, or for seven semi-annual installments from January 1, 1911, to July 1, 1914, at 4% each, or a 28% dividend on the increase or stock dividend, and this dividend was the proceeds of the liquidation of these arrears. At a meeting of the Board of Directors of the Northern Central Railway Company held December 11, 1906, the following resolution declaring a stock dividend was passed: “Resolved, That, to represent a portion of the surplus profits of the company hitherto expended in betterments to its property, there be declared an extra dividend of 6 25/100 Dollars upon each share of the present capital stock as registered on the books of the company at 3 P. !£., December 31st, 1906, the said extra dividend to be payable on and after January 15th, 1907, in the stock of the company at its par ²⁵ value of Fifty Dollars per share, the certificates for the same to be dated January 1st, 1907, and to be entitled to participate in any dividends that may be declared after said date, scrip to be issued for any fraction of a share, redeemable in the stock of the company, when presented in sums of Fifty Dollars or multiples thereof, under such regulations as the Board may prescribe.” Under the Public Service Commission law of the State it was necessary to secure the approval of the Public Service Commission to the settlement, terms and conditions of the lease above mentioned. Accordingly the Northern Central Railway Company on the 5th day of December, 1910, filed a petition with the Commission asking it to approve the proposed lease of its railway, property and franchises, to the Pennylvania Railroad Company on the terms and conditions ■set out in the lease, a copy of which was filed with the petition, and also asking the Commission to pass an order— “authorizing said Railway Company to issue capital stock, that is to say, one hundred and fifty-four thousand, seven hundred and forty-one (154,741)