                   THEATTORNEY                        GENERAL
                                    OP      TEXAS

                                    AUHTIN 11. -~-EXAE
PRICE   DANIEL
.4TTOFlNEY
         GENERAL
                                               August 29, 1952


              Hon. Sack Ross                              Opinion No. V-1520
              Secretary of State
              Austin, Texas                               Re:   Issuance of stock dividends
                                                                out of surplus. created by an
                                                                appreciation in the value of
              Dear Sir:                                         corporate assets.

                           your office has requested an opinion on the follo+ng          &es-
              tion:

                           “Can appreciation in the value of the assets
                      of a corporation form the consideration for the
                      issuance of additional capital stock by means of           ‘,
                      a stock dividend to its stockholders 7”

                          According      to the records    and information furnished with
              your request, the fact situation out of which the above question
              arose is as follows: A corporation chartered in Texas in 1923
              with capital stock of $250,000 has made application to increase
              its capital stock to $500,000. The increase is to be made by
              means of a stock dividend aggregating $250,000, to be,distributed
              to present stockholders in the same proportion as their present
              stock ownership. The assets of the corporation have been re-
              cently appraised by an independent and reputable firm’ of apprais-
              ers, and based on present values the appraisal shows the corpora-
              tion’s surplus to be in excess of the $250,000 which it proposes
              to convert into capital stock. You have stated that you are satis-
              fied that the assets are presently worth the resppraiaediraluez.All
              of the stockholders of the corporation and all of the directors have
              authorized the proposed increase.

                        It appears from the factual statement submitted by the cor-
              poratlon tbat a portion of tbe surplus has resulted from investment
              of earnings in plant expansions, We have not been furnislied with
              prior financial statement6 ff the corporation, and consequently we
              do not know to what extent the stated surplus has resulted from ap-,
              preciation in the value of amet    since the date of tI+acquisftion.
              However, your question aecrssmdly      spumes %hat a portion of the
              stated surplus repraents appreciation in the value of corporate
              assets.

                          ArticJe   XII. Section 6 d the Texas Comtitutlon provides:
                                                                                                 .’
                                                                                                      _,




                     Hon. Jack Ross; page 2           (V-1520)



                            “No corporation shall issue stock or bonds
                         except for money paid, labor done or property
                         actually received, and all fictitious increase of
                         stock or indebtedness shall be void..

                                 Article   1353, V.C.S.,   reads:

                              “No corporation shall issue any stock what-
                         ever, except for money paid, labor done, which is
                         reasonably worth at least’the sum at which it was
                         taken by the corporation, /or property actually re-
                         ceived reasonably worth it least the sum at which
                         it was taken by the cornPi ny. Any corporation
                         which violates any provision of this article shall,
                         on proof thereof in any court of .competent juris-
                         diction, forfeit its charter, permit or license, as
                         the case may be, and all rights and franchises
                         which it holds under, from, or by virtue of the
                         laws of this State.”

                               There are no cases by the Supreme Court of Texas di-
                     rectly in point on the question of whether appreciation in the value
                     of the corporate assets fulfills the constitutional and statutory re-
                     quirements of money paid, labor done or property actually re-
                     ceived is the consideration for the issuance of a stock dividead.

                              In O’Bear-Nester    Glass Co. v. Anti-Explo Co., 101Tex.
                     431,108 S.W. 9b7 m)       the Supreme Court said with regard to
.:~:
                     gection 6 of Article XIII
       ,’   .



                                      The purpose of the convention in enact-
                         ing ~t~p&vision    of the Constitution was to se-
                         cure creditors as.well as stockholders of corppra-
                         tfons against the practice which was too common,
                         of cdrporatiom   @suing fic~titiom,,stock and. stock,
                         upon an insufficient consideration, whereby the
                         actual capital was much less than ~theamount rep-
                         risented by the shares issued and sold by the car-
                         poration.   The terms in which this section of the
                         Constitution is expreseod indicates the purpose
                         that,the assets of the corporatfon should bo some-
                         thing substantial, and of such a character that they, .’
                         could be subjected to the payment of claims igainst
                         the corporation as well as to secure the aharehold-
                         ers in their rights in the capital dock.”       ,’

                                 in Cattlemen’s    Trust Co. of ,Ft. Worth v. Turner, l&3 S.W.
                ::   ,438 (Tea     Civ. AAT          reverse  on 0 er groun s.    urns3 v.
Hon. Jack Ross, page 3      (V-1520)



Cattleman’s Trust Co,, 215 S.W. 831 (Tex. Comm. App. 1919). the
Court  explained the purpose of these constitutional and etatutoiy
provisions as follows:

          -By the common law of the land owners ,of
    stock in corporations are entitled to a’ratable
    share in its assets, and,the evident purpose of
    the constitutional and statutory provisions under
    consideration was to protect the purchasing pub-
    lic in the acquisition of stock ,or bands of ear-
    porations that was not represented by an equiva-,
    lent’.in the way of assets belonging to the corpora-
    tion issuing the stock, . . .”

          If the only purpose of the constitutional and statutory pr,o-
visions is to protect present and prospective creditors and stock-
holders against a fictitious increase in values, as these two cases
indicate, it is difficult to see how the proposed stookdfvfdend in
the present case would be illegal. ,In order to ascertain if there
will be a possibility of harm,, to stockholders or creditors, it is
ne.eessary to understand the nature of a stock dividend. In a re-
cent opinion (Letter Opinion to Hon. John Ben Shepperd dated
April 11, 1951). this office approved the following deftnition of a
stock ,divfdend as stated in 13 Am.Jiir.. Corporations, 8 648:

          “In its ordinarily accepted meaning a stock
    dividend is a dividend payable in stock instead
    of cash, the declaration of which involves the
    creation or issuing of new stock to be distributed
    pro rate to the shareholders as evidence of the
    contemporaneous transfer of an equivalent amount
    of the surplus earnings or profits to the capital
    fnnd of the corporation. A cash dividend differ@
    matrrklly from a stock,divfdend in that a cash
    dividend, being declared on the then existing cap-
    ital dock, subtracts so much from the trea-sury~,
    of the corporation and transfers’it to the pocket
    of the stockholder, while a stock dividend takes
    nothing from the property of the corporation and
    adds nothin% to the interests of the rtockbolders.
    A hxk~dividmd       implies a continuance of the cork
    porath     *itb the Bama asmets and the lame Ul+i-
    ities, The title ta all corporate property remins
    in the corporaUoia a8 bofwe, bt+cOrpora~       pQfi*
    or surplus ir prunaently      lpproprkbd to fixed
    capital, the shareholders receiving merely symbols
    or evidences of such appropriation. Where a atack
    dividend issues, Uw t%nterprise rem&s      the same;
    the increase Pn capital dock simply dilutes tha
     shares as they aatMOd’-Lur-’
Hon. Jack Ross, Rage 4      (V-1520).



          You state that you are satisfied that the assets of the eor-
poration are worth the reappraised value, In the light of the above
explanation of the nature of a stock dividend, we fail to see a likeli-
hood of injury from the proposed increase in capitalization.

          Neither the O’Bear-Nester    case nor the Turner case men-
tions increase in capitalization or issuance of stockd      on an
enhancement in the value of the corporate assets. Two opinions by
Courts of Civil Appeals have said that increased value of the assets
could not support a stock issue.

          In Houston Cemetery Co. v. Drew, 36 S.W. 802 (Tex. c,iv.
App. 1896, error dism.), the question decided by the Court of’Civi1
Appeals was whether the district court had actad’properly in aI;-
pointing a receiver for the corporation Rending a hearing on the
merits. One ,of the grounds upon which the appointment was sought
was that the corporation had issued watered stock. On this point
the court said by way of dictum:
          . . . . The capital stock was afterwards increased
    to $100,000, upon the estimated increase in value of
    the land bought for the purposes of the cemetery; and
    the certificates of stock were issued to the shareholders
    at the ratio of 16 of ‘the new shares for 1 of the old. This
    was apparently within the inhibition of the constitution
    (article 12, 8 6) against the issuance of stock except for
    money Raid, labor done, or property actually received.”

          In Cole v. Adams, 49 SW. 1052 (Tex. Civ. ARp. 1898). tbe
receiver of an insolvent corporation brought suit to compel payment
by the stockholders of the balances alleged to be due upon the stock
issued to them. The corporation had been chartered on September
27, 1889, and after organization the defendants conveyed certain
real estate, for which they had paid $14,000, and certain contract
rights to the corporation.   On May 22, 1890, it wae estimated that
the actual value of the property, rights, and franchisee,tiien owned
by the corporation,,,inqluding .enhan~ementin value of .the .real prop-
erty ‘air@ tts con&+%       to $he...&ovbofat.fon,over and above’ite~ ini ,
debtednessi was $28,000: Basti on that+aluation, the corporation
issued 40 shares having a par value ,,of $100 to each of the seven de-
fendants, Between that date and September 1, 1890, six of the defend-
anta: had contributed $500 each to the corporation, and that to-
gether with $10,000 out of earnings of the corporation had been in-
vested in further plant expansions. On September 1, by agreement
of the stockholders, the corporation issued 10 additional shares :
.to each nf, six of the defendants. Tbe receiver sued each of the de-
fendants for 50,per cent of the par value of the shares issued to him,
upon thetheory~that the defendants were not entitled to credit for “es-
timated enhanced value of the properties of the corporation,contracts,
Hon. Jack Ross, page 5      (V-1520)



proceeds, extensions made, and earnings from operation of the
plant between the dates of the charter and the issuance of the
stock.” The Court of Civil Appeals sustained the receiver’s
right to recover for amounts based on enhanced value:

         “The appellants, under their first and second
    assignments of error, submit these, two proposi-
    tions: (1) The corporators who were not subscrib-
    ers for capital stock were entitled to shares of Raid-
    up capital stock to the full value of the property and
    effects owned and held, by the corporation over and
    above its indebtedness at the time the stock was is-
    sued. (2) The corporators and stockholders of a
    corporation are the real and beneficial owners of
    all the property and effects held by the corporation,
    and they are entitled to full paid up shares of stock
    for the value of the property and effects of the cor-
    poration over and above the liabilities of the corpora-
    tion. We cannot assent to either of these propositions.
    The relation of the corporators to the corporation in
    respect to its capital stock is not different from that
    of subscribers for the stock. Stock can be issued to
    neither, except for money paid, property conveyed or
    sold to the corporation, or labor done for it. The
    stock, it is well settled, which is unsold, is to be held
    a$ a security for the creditors of the corporation; and
    an enhancement of the value of the properties of the
    corporation will not authorize an additional issue of
    the etook to either corporators or subscribers for the
    stock.
         I)
            . , . ‘From what we have said, it follows that
    we thfnk the court did not err in refusing to consider
    the alleged enhancemsnt in the value of the franchises
    and properties of the corporation between the datas of
    the acquisition if [sic] its properties and that of the
    issuance of 8toFr me       corporators, as any part of
    the cqneideration for which the stock was sold. . . .”

           In an earlier opinion involving the same fact situation,
Cole v. Adams, 92 Teat, 171,46 S.W. 790 (1898), the Supreme Court
in answering certified questions bad made’ statements which, taken
alone, we would be fnelined to construe as holding that enhancement
in value between the time the property was transferred to the cor-
poration and m time the stock was issued could constitute the con-
 sideration for the issuance of stock. But the Court of Civil Appeals
 evidently did hot so construe tbe Supreme Court’s answers to its
 questions, and we do uot feel at liberty to substitute our interpreta-
 tion of the holding for that nnde by the Court of Civil Appeals.
 Hon. Jack Ross, pnge 6      (V-l520),




            The recent case’of Adams v. Farmers Gin Co., 114S.W.,,
 i2d ~583(Tex. Civ. App. 1938), indirectly supports tbe ho ir     rgin :
,~Gole v, madams. Tn that case the corptirath     had issued apprti-
  imatelyres           of stock at;a par value of $25 per share. or
  an aggregate value, of about $3,ObO. Subeequently~ the gin &ieh
  the corporation owned and operated bad burned, and the corpora-
  tion bad’received $&O,OOOin insurance. This sum, together with’
  the land on whjch the gin stood, constituted the corporationfd   as-
  sets at the time a stockholders’ meeting was held to decide whetb-
  er the cor’poration should dissolve or should rebuild and contfnue
  in operation. At that meeting, it was agreed that the stockholders
  would “loan” to the corporation the amount which they would have
  received~upon dissolution (about $125 parsebare) and that the cbr-
  poration would build another gin and repay the “loana” out of fu-
  ture profits. Certain ,of the stockholders  sued to recover the 10-
  Raid portion of the so-called y108ns.e and in the alternative they,
  contended that.the agreement amounted to the declaration of a
   stock dividend. The Court of Civil Appeals rejected this conhn-
  tion in the following language:

            -Article 12, section 6, of the Constitution of
      Texas, quoted abwe, is. we~think, a completean-
      swer to plaintiffs’ proposition No. 1, that is, their
      contention tbat a stock dividend was declared. A
      finding that a stock dividend was declared would not
      have ,found clupport in either the pleadings or evi-~
      dence. The charter fixed the amount and par value
      of the stock. No action for the creation of preferred
      stock was taken. No amendment of the charter and
      the approval and filing of same by the Secretary of
      State, as required by article 1314,is shown. Plain-
      tiffs paid no money and performed no labor and the
      corporation received no property from ,them as a ,.
      legal basis for the issuance of stock. No net profits
      are shown to have been earned and unpaid on May 1.
      1926. As heretofore stated, the corporatiop then
      held and owned the insurance money and all other ae-
      sets. There was no transfer or conveyance of prop
      erty, either actually, or in legal e~ffect,,‘from the   ’
      etockholdore to the corpordion as a lawfulbaeir for
      a debt or for, stock of the corporation. An agreement
      to pay tho stockhdders cannot be enforced as a de-
      clared dividend or otherwise6 except upon dissolution
      of the corporation, Dividends may be paid oat of
      profits but not out of thw capital aeswtu of tlae cot-,
      poration.g                             .
         -




             Hon. Jack Rotis, page 7     (V-UZO)




                       In the three cwer lart cited, thwcourt &I each inetance
             unmistakably indicated that an iacreare in tbe value of the cor-
             porate ascleta would not support UIe dochratbn      of a dock divi-
             dend. Ar against the gonerel rtabmenta in the O’Bear-Neater
             and Turner casen, we mwt       accept #here exprereiona as being
             more-y         decisive of tlw #cope of the prohibition contained
             in Saction 6 of Article XII of tbe ConaWuUon. Consequently,
             it is our opinion that thin sectia, of the Constitution forbid6 the
             issuance of additional capital ltwk ia the form d a stock divi-’
             dend baaed on the appreciated valw of corperati       awets.


                                         SUMMARY

                      Art. XII, Sec. 6 of the T-8    Coastitutlon pro-
                 hibits a corporation from iomdag aphl       dock
                 based on the appreckted tilw     of the corporate
                 assets.

                                                   Youm very truly,

                                                   PRECE DANIEL
             APPROVED:                             Attorney General

             ‘E. Jacobrat
              Reviewing Asclirtant

             Chnrles D. Mathewe
             Fir& Ad&ant




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