Court
Circuit Court of the United States for the Western District of Michigan, Southern Division
Decided
Judge
LURTOX, Circuit Judge
Posture
Decree against defendants Messrs. Fox on both grounds of unpaid stock subscription and conversion of corporate assets
Defendants (1)
RICKERSON ROLLER-MILL CO. et al.
Albert Crane
v.
Plaintiff (1)
FARRELL FOUNDRY & MACHINE CO.
A. O. Denison
Other parties: S. B. Rickerson — Promoter and stockholder, O. E. Brown — Stockholder, S. W. Ousterhout — Stockholder and director, James L. Wheeler — Stockholder, E. C. Fox — Stockholder and director, Charles Fox — Stockholder and director, John Hutchison Manufacturing Company — Purchaser of corporate assets
Overview
The decree is reversed as to the Fox brothers' liability for unpaid stock subscription, but affirmed as to the invalidity of their preference as creditors. The assets transferred to the Fox brothers should be ratably distributed among all creditors, including themselves. Costs of appeal are equally divided.
Case summary
This case involves a corporate creditor's attempt to recover from stockholders and directors of an insolvent corporation. The Rickerson Roller-Mill Company was formed with $100,000 in stock issued for patent rights, then increased its capital to $150,000, selling $50,000 of stock to E.C. and Charles Fox for $25,000 (50% of par value). The corporation became insolvent, and the Farrell Foundry & Machine Company, a creditor, obtained judgment and sought to hold the Fox brothers liable for the unpaid balance on their stock and for corporate assets they had transferred to themselves as preferred creditors. The Circuit Court of Appeals held that: (1) the Fox brothers were not liable for debts incurred after the Farrell Company had notice of the stock sale terms; (2) the directors' preference of themselves was invalid due to lack of good faith, as they had assured the Farrell Company its claim would be paid first; and (3) payments on the running account between the companies were properly applied to the oldest items, not specific middle items as the creditor claimed. The court reversed the liability for unpaid stock but affirmed the invalidity of the preference to directors.
Abstract
A corporate creditor sought to hold stockholders and directors liable for unpaid balances on discounted stock and for invalidly preferring themselves as creditors in an insolvent corporation. The court reversed liability for the unpaid stock subscriptions due to the creditor's notice of the sale terms but affirmed the invalidity of the directors' self-preference for lack of good faith, requiring ratable distribution of transferred assets among all creditors. Costs of appeal were equally divided.
Opinion of the court
Majority
opinionLURTOX, Circuit Judgejoined by TAFT, ETAMMOXD
opinionLURTOX, Circuit Judgejoined by TAFT, ETAMMOXD
- Stock issued for new capital purposes creates same liability as original stock
- Creditors with notice of stock sale terms cannot recover difference from purchasers
- Directors must show utmost good faith when preferring themselves as creditors
- Payments on running account presumed to apply to oldest items absent specific application
Jurisdiction
not challengedSubject matter
Diversity jurisdiction or federal question involving corporate law and creditor rights
Jurisdictional facts
- Appeal from Circuit Court of the United States for the Western District of Michigan
- Case involves interpretation of federal and state corporate law principles
Procedural posture
Posture at trial
Decree against defendants Messrs. Fox on both grounds of unpaid stock subscription and conversion of corporate assets
Posture on appeal
Direct appeal from circuit court decree
Preserved issues
- Liability of stock purchasers for unpaid stock
- Validity of preference given to directors
- Application of payments to running account
Subsequent history
Petition for rehearing
not filed
Legal categories
Business
Case record
Full case name
RICKERSON ROLLER-MILL CO. et al. v. FARRELL FOUNDRY & MACHINE CO.
Docket number
No. 386
Court
Circuit Court of Appeals, Sixth Circuit
Trial court
Circuit Court of the United States for the Western District of Michigan, Southern Division
Decided
Opinion author
LURTOX, Circuit Judge
Opinion type
published
Precedential status
precedential
Judges on panel
TAFTLURTOXETAMMOXD
Issues & holdings
3
Issues raised
2
reversed
1
affirmed
3
Holdings
1
Whether purchasers of corporate stock issued at less than par value for purpose of providing new capital are liable to creditors for the difference between price paid and par value
reversed
Standard of review
de novo
Disposition rationale
Fox brothers not liable for debt incurred after Farrell Company had notice of stock sale terms
Preservation
Issue preserved for review
2
Whether directors of insolvent corporation acted in good faith in preferring themselves as creditors through transfer of corporate assets
affirmed
Standard of review
clearly erroneous
Disposition rationale
Directors violated moral trust by preferring themselves after assuring other creditor of priority
Preservation
Issue preserved for review
3
Whether payments on running account should be applied to oldest items (head) or specific middle items as claimed by creditor
reversed
Standard of review
clearly erroneous
Disposition rationale
Creditor failed to meet heavy burden of proving arbitrary application of payments to middle items
Preservation
Issue preserved for review
Holdings of the court
Liability of stock purchasers for unpaid stock
Purchasers of stock issued at less than par value for purpose of providing new capital are liable to creditors who extended credit without knowledge of the arrangement, but not to creditors with knowledge
Stock issued to provide new capital stands on same footing as original stock; creditors with notice cannot claim reliance on full payment
unanimousbinding precedent
Validity of preference to directors
Directors who prefer themselves as creditors must show utmost good faith; preference invalid when directors assured other creditor of priority then preferred themselves
Directors violated moral trust by using corporate assets to prefer themselves after inducing forbearance through assurances of fairness
unanimousbinding precedent
Application of payments to running account
When no specific application of payments is made, law presumes payments apply to oldest items of account; creditor bears heavy burden to show different application
Rule from Devaynes v. Noble establishes presumption that payments apply to head of account; unexplained pencil memoranda insufficient to overcome presumption
unanimousbinding precedent
Error analysis
- Trial court erred in holding Fox brothers liable for unpaid stock subscription for debts incurred after creditor had notice — legal · error foundError not harmless as it affected substantive rights of parties · not harmless
- Trial court erred in finding creditor proved arbitrary application of payments to middle items of account — evidentiary · error foundFactual finding clearly erroneous based on evidence · not harmless
Statutory interpretation
1Statute
Michigan general corporation law
Question
Whether corporation can agree to accept less than par value for stock
Court's reading
Corporation may agree with subscriber to accept less than par, but agreement not valid against creditors without notice
Burden of proof
Prosecution burden
Preponderance of evidence in equity proceeding
Burden met
Partially - creditor met burden on preference issue but not on stock liability or payment application
Standards of review
- Interpretation of corporate law principles regarding stock subscriptions — de novo Legal questions regarding liability of stock purchasers reviewed de novo
- Factual findings regarding application of payments and director good faith — clearly erroneous Trial court's factual determinations reviewed for clear error
Timeline
7
Events
1,964
Days, incident to ruling
—
Span
procedural eventcited in opinion
O. E. Brown Manufacturing Company incorporated under Michigan law with $100,000 capital stock
Corporation formed to manufacture Rickerson patent roller mills
factual eventcited in opinion
Capital stock increased to $150,000; Fox brothers purchase $50,000 of stock for $25,000
Stock issued at 50% of par value for purpose of providing new capital
factual eventcited in opinion
Account opened with Farrell Foundry & Machine Company for purchase of rolls
Beginning of creditor relationship central to the case
factual eventcited in opinion
Farrell Company receives notice of terms of stock sale to Fox brothers
Notice affects creditor's ability to recover from stock purchasers
factual eventcited in opinion
Corporation resolves to dispose of assets due to unprofitability
Beginning of liquidation process
factual eventcited in opinion
Directors Fox and Ousterhout transfer corporate assets to themselves to secure their endorsements
Preference to directors challenged as invalid
factual eventcited in opinion
Remaining uncollected claims transferred to Fox brothers and Ousterhout
Further asset transfer to secure director claims
Facts & evidence
Incident
Location
Grand Rapids, Michigan
Key facts
9 facts- S. B. Rickerson applied for patent for roller mill improvements in 1882
- O. E. Brown Manufacturing Company incorporated December 15, 1882 with $100,000 capital stock issued to Rickerson and associates for patent rights
- Capital stock increased to $150,000 on March 1, 1883
- E. C. Fox and Charles Fox purchased $50,000 of increased stock for $25,000 (50% of par value)
- Corporation began operations with no cash capital, only patent rights
- Farrell Foundry & Machine Company supplied rolls on credit from May 1883 to July 1887
- Corporation became unprofitable and insolvent
- Directors Fox and Ousterhout transferred corporate assets to themselves in October 1887 to secure their endorsements on corporate debt
- Farrell Company obtained judgment against corporation and sought to hold Fox brothers liable for unpaid stock and converted assets
Disputed questions
- Whether Fox brothers' stock purchase was for new capital or restoration of impaired capital
- Whether Farrell Company had notice of stock sale terms when extending credit
- How payments should be applied to running account between corporations
- Whether directors acted in good faith in preferring themselves as creditors
Procedural history
4 steps- Original bill filed by Farrell Company as judgment creditor
- Sought relief on two grounds: unpaid stock subscription and conversion of corporate assets
- Circuit court entered decree against Fox brothers on both grounds
- Appeal to Circuit Court of Appeals
Evidence in the record
Testimonial
- Testimony regarding negotiations for stock purchase
- Evidence of notice to Farrell Company of stock sale terms
- Testimony regarding application of payments to account
Documentary
- Articles of incorporation of O.E. Brown Manufacturing Company
- Stock certificates showing fully paid status
- Book accounts between Rickerson Company and Farrell Company
- Letters between corporations regarding credit terms
- Resolution increasing capital stock
- Agreement assigning patent rights to corporation
Challenged
- Evidence type: Pencil memoranda on ledger margin · Challenge basis: relevance and reliability · Trial court ruling: considered · Reasoning: Unexplained memoranda insufficient to overcome presumption of payment application · Challenged on appeal: true · Appellate outcome: reversed
Jury
Verdict
Not applicable - equity proceeding
Sentencing
Sentence challenged on appeal
false
Objects of relevance
Roller mill machinery and rolls purchased on creditPatent rights for roller mill improvements
Policy considerations
- Protection of creditors who rely on corporate capital representations
- Importance of good faith by corporate directors in handling insolvent corporation assets
- Need for predictable rules in commercial transactions and credit relationships
Authorities
Cited authorities (4)
Handley v. Stutz, 139 U.S. 417, 11 Sup. Ct. 530
distinguishedquoteddistinguishedDistinguished as involving sale of stock of going concern with impaired capital, not new capital
Clark v. Bever, 139 U.S. 96, 11 Sup. Ct. 468
distinguishedquoteddistinguishedDistinguished as involving stock taken by creditor of insolvent corporation in settlement of debt
Devaynes v. Noble, 1 Mer. 597
followedquotedprecedentCited for rule that payments on running account presumed to apply to oldest items
Scovill v. Thayer, 105 U.S. 143
followedquotedprecedentCited for trust fund doctrine that corporate stock is trust fund for creditors
Related cases (4)
Handley v. Stutz, 139 U.S. 417, 11 Sup. Ct. 530
prior appealDistinguished - involved sale of stock of going concern with impaired capital, not new capital
Clark v. Bever, 139 U.S. 96, 11 Sup. Ct. 468
prior appealDistinguished - involved stock taken by creditor of insolvent corporation in settlement
Fogg v. Blair, 139 U.S. 118, 11 Sup. Ct. 476
prior appealDistinguished - similar to Clark v. Bever
Devaynes v. Noble, 1 Mer. 597
precedentFollowed - established rule for application of payments to running account
Statutes
- Michigan general corporation law
Standards & doctrines
- Trust fund doctrine for corporate capital
- Presumption of payment application to head of account
- Good faith requirement for director preferences
Legal principles applied
- Creditors without notice may recover unpaid stock balances from purchasers
- Directors must show utmost good faith when preferring themselves
- Payments presumed to apply to oldest account items absent specific application
Notable quotes
“The liability of a subscriber for the par value of increased stock taken by him may depend somewhat upon the circumstances under which, and the purposes for which, such increase was made.”majority — Discussing distinction between stock issued for new capital versus impaired capital restorationEstablishes key principle for determining stock purchaser liability
“When credit is extended to a corporation with full knowledge of special arrangements between the corporation and purchasers of the stock whereby nonassessable stock has been issued for less than its par value, it cannot be said that such credit has been extended in reliance that the stock has been fully paid.”majority — Explaining why creditors with notice cannot recover from stock purchasersEstablishes notice as defense to stock liability claims
Index terms74
Summary terms
Legal mechanisms
Various actions
Various actors
Legal concepts
Legal outcomes
Legal issues
Legal procedures
Legal remedies
Legal evidence
Legal arguments
Legal defenses
Legal penalties
Legal procedural steps
Geo locations
Judges
Attorneys
Procedural terms
Substantive offenses
Entities and documentation
Legal actions
Action type
reversed in part
Target
trial court decree holding Fox brothers liable for unpaid stock subscription
Appealed from
Circuit Court of the United States for the Western District of Michigan
Context
Reversed as to Fox brothers' liability for unpaid stock for debts incurred after Farrell Company had notice of stock sale terms
Scope
in part
Further instructions
Fox brothers not liable for debt incurred after creditor had notice
Disposition vote
unanimous
Action type
affirmed in part
Target
trial court decree invalidating preference to directors
Appealed from
Circuit Court of the United States for the Western District of Michigan
Context
Affirmed finding that directors violated good faith by preferring themselves after assuring other creditor of priority
Scope
in part
Further instructions
Assets transferred to directors to be ratably distributed among all creditors
Disposition vote
unanimous
Action type
reversed
Target
trial court finding regarding application of payments to account
Appealed from
Circuit Court of the United States for the Western District of Michigan
Context
Reversed finding that payments were arbitrarily applied to middle items of account
Scope
full
Further instructions
Payments presumed to apply to oldest items of account
Disposition vote
unanimous
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