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TMI Blog1961 (2) TMI 32X X X X Extracts X X X X X X X X Extracts X X X X ..... he event of the company being wound up to be paid out of the surplus assets of the company the amount paid up in respect of such preference shares and all arrears (if any) of dividend thereon up to the date of the commencement of the winding up in priority to the other shareholders, and to participate in any further surplus assets of the company after payment of the amount paid up in respect of the other shares rateably with the other shareholders in proportion to the amount paid up on the said preference shares and the other shares respectively. " The memorandum provided that the unclassified shares might be issued as ordinary, preference or deferred shares, or partly in one such manner and partly in another, and the articles authorised the issue of any of these shares or any new shares created on an increase of capital as preference shares ranking pari passu with the original preference shares, but so that the number of preference shares at any time issued should not exceed one-third of the issued share capital of the company. Voting was regulated by article 54 as follows : "Every member shall have one vote for every ten shares held by him. A member shall not be entitled to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of shares. They contained a variation of rights clause but no use was made of this in respect of any of the matters in question. In May, 1910, the company by special resolution adopted an article authorising the subdivision of shares, and thereupon subdivided the ordinary shares of 5 each, which were then 22,933 in number, into 114,665 ordinary shares of 1 each, and further resolved that any farther shares to be thereafter issued as ordinary shares should be divided into and issued as 1 shares. The result of this was to multiply the votes of the ordinary shareholders greatly. In 1911, however, this position was rectified or altered by another special resolution substituting for article 54 a new article which gave ordinary shareholders one vote for every five ordinary shares held, and to preference shareholders one vote for every preference share held. In 1920 the company by special resolution adopted a new article authorising capitalisation of undivided profits. On April 14, 1920, the company increased its share capital to 250,000 by the creation of 50,000 ordinary shares of 1 each. On the same day the company capitalised a sum of 42,044 in the form of ordinary shares dis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid-up shares or securities by way of capitalisation of ( i ) credit balance on profit and loss account and other revenue reserves, ( ii ) reserves resulting from the realisation of capital profits, ( iii ) reserves resulting from the revaluation of capital assets, or ( iv ) share premium account, and (5) whether on a poll ( a ) every member holding ordinary shares had one vote for every five ordinary shares held by him, and every member holding preference shares had one vote for every preference share held by him, or ( b ) the members were entitled to some other voting rights. J.G. Monroe for the company. P.J. Sykes for the first defendant, a representative preference shareholder. T.D.D. Divine for the second defendant, a representative ordinary shareholder. The following cases, in addition to those referred to in the judgment, were cited in argument: Crichton Oil Co. Ltd. In re [1901] 2 Ch. 184 ; 18 T.L.R. 556, C.A. ; Odessa Waterworks Co. Ltd. In re [1901] 2 Ch. 190 n; Bishop v. Smyrna and Cassaba Railway Co. [1895] 2 Ch. 265 ; 11 T.L.R. 393. Cur. adv. vult. Feb. 2. Buckley J. read the following judgment in which he stated the facts and continued: Q ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fter not only paying creditors and costs but also extracting distributable profits to which any class of shareholders may have become entitled before the winding up began because of the reference to payment out of the surplus assets of arrears of the preference dividend. Moreover, if by virtue of the original article 85 the ordinary shareholders become entitled, as they accrue, to all profits of the company not required for payment of the preference dividend, notwithstanding that such profits remain undistributed, Mr. Sykes says that it is hard to see what surplus assets could be left over in a winding up after paying creditors, costs and arrears of preference dividend, repaying paid-up capital and distributing to the ordinary shareholders the undistributed profits to which they would have so become entitled. On the other hand, Mr. Divine, on behalf of a representative ordinary shareholder, contends that the present case is governed by the decision in Bridgewater Navigation Co, In re [1891] 2 Ch. 317 ; 7 T.L.R. 360, C.A. ; [1891] 1 Ch. 155 , that the undistributed profits of the company not required for payment of the preference dividend become appropriated to and belong to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ue interpretation of the original article 5 read in the context of the rest of the original articles of the company. The fact that the ordinary shareholders might be able to defeat the expectations of the preference shareholders to participate in a winding up in undistributed profits is not necessarily inconsistent with the preference shareholders having such a right. In article 5( b ) the expression "surplus assets" is used twice. Where it first appears it must clearly mean property of the company remaining after the external liabilities of the company have been discharged and provision has been made for the costs of the winding up, but before any capital has been repaid to the preference shareholders or any arrears of preference dividend have been satisfied, and a priori before any capital has been repaid to the ordinary shareholders or any profits have been distributed to them. In other words, "surplus assets" here means all the assets of the company remaining after creditors have been paid and the costs of winding up have been paid or provided for, but before any payment to members as such has been made or provided for. The article confers on the preference shareholders a rig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f Lords had not decided the proper destination of the undistributed profits in question before them : presumably this would properly be described as relating to the adjustment of the rights of the shareholders inter se. The decisions of North J. and the Court of Appeal turned mainly upon the terms of article 85 of the company's articles of association, which I have read. Having regard to the creation of the preference shares with a limited right to participate in profits North J. held [1891] 1 Ch. 155, 168 that that article should be treated as though it read "shall after payment of the dividend to the preference shareholders belong to and be divided pro rata among the ordinary shareholders of the company." He consequently held that the ordinary shareholders were exclusively entitled to the net profits of the year current at the date of liquidation, subject to paying an apportioned preference dividend to the preference shareholders, and to a sum reserved but not required for canal improvements, but not to certain other reserves. The Court of Appeal [1891] 2 Ch. 317 varied the order of North J., holding that the last-mentioned reserves also represented undistributed profits, which h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any was still a going concern. In reaching this conclusion they were largely influenced by the circumstance that the articles gave the ordinary shareholders complete control of these profits until liquidation. I think that the decision may be summarised as follows : (1) the article regulating the distribution of profits did not in terms state that profits remaining after paying the preference dividends should belong in any event to the ordinary shareholders; (2) the article dealing with rights in a winding up was silent about whether the preference shareholders should or should not participate in surplus assets available for distribution after repayment of all paid-up capital; (3) it was clear that until liquidation began the ordinary shareholders could, by means of dividends and capitalisation, appropriate to themselves all the undistributed profits not required to pay preference dividends. The majority of the House of Lords considered the last-mentioned circumstance to afford the clue to the proper construction to be adopted as regards (1) and (2) see per Lord Maugham [1949] A.C. 462, 479-480 , Lord Simonds Ibid. 488 and Lord Normand Ibid. 494. As regards (1), the Wilso ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fits which the ordinary shareholders choose to leave undistributed until after the commencement of a winding up. Having regard to the analysis which I have made of the language of paragraph ( b ) of article 5 I feel compelled to the view that in the present case the preference shareholders would be entitled to participate in a winding up rateably with the other shareholders in all the assets of the company which remain after paying creditors, costs and arrears of the preference dividend and after repaying all paid-up capital. I do not think that either the Bridgewater s case ( supra ) or the Wilsons Clyde s case ( supra ) requires or enables me to reach another view. Indeed, I think that part of Lord Simonds' reasoning in the latter case strongly supports my view. He said [1949] A.C. 462, 488 ; 19 Comp. Cas. 202 , 215: "There is another somewhat general consideration which also, I think, deserves attention. If the contrary view of articles 159 and 160 is the right one and the preference stockholders are entitled to a share in surplus assets, the question will still arise what those surplus assets are. For the profits, though undrawn, belong, subject to the payment of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r dividend up to the date of the commencement of the winding up, and after providing for costs. I come now to the question of the effect of the capitalisation article, article 140 in the company's new articles of association. Mr. Sykes' first submission with regard to this was that if this article in any respect varied, or purported to vary, the rights of the preference shareholders, it is to that extent not binding on them. This must be right, because the rights of the preference shareholders are by reference written into the memorandum of association and so are only capable of variation by a scheme of arrangement sanctioned by the court under the Companies Acts, except that possibly the rights so written into the memorandum ought to be taken as capable of being varied in accordance with the modification of rights clause contained in the original articles of association, but this clause, as I have stated, has never been operated. Accordingly the question raised by the originating summons in respect of article 140 involves first the consideration of whether under the terms of that article amounts standing to the credit of all or some, and if so which, of the accounts referred t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 105, 107: "I am of opinion that these observations are sound, and that particularly in the case of an appreciation, which is neither realised nor immediately realisable, it would be illegal to distribute the surplus." Lord Sorn said Ibid. 109: "In my view, capital profits are not distributable until they are realised." Founding himself on these observations Mr. Sykes contends that a reserve fund resulting from a revaluation of fixed assets could not legitimately be distributed by way of dividend. Consequently, he says, it cannot legitimately be capitalised. It is to be observed that article 140 provides that the capitalised sum is to be "appropriated as capital to and amongst the shareholders who would have been entitled thereto if the same had been distributed by way of dividend in the shares and proportions in which they would have been so entitled." These words are common form in articles of this kind, and I think that it is correct to say that a capitalisation of this sort is in essence the declaration of a dividend combined with the application of that dividend on behalf of the shareholders entitled to participate in it in paying up shares to be allotted and issued to them ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a surplus so ascertained should not be distributed in that manner. After all, every profit and loss account of a trading concern which opens and closes with a stock figure necessarily embodies an element of estimate. The difference between ascertaining trading profits by, amongst other things, estimating the value of the stock in hand at the beginning and end of the accounting period, and ascertaining capital profits by comparing an estimated value of the assets with their book value, appears to me to be a difference of degree but not of principle. Moreover, if a company has fluid assets available for payment of a dividend, I can see nothing wrong in its using those assets for payment of a dividend, and at the same time, as a matter of account, treating that dividend as paid out of a capital surplus resulting from an appreciation in value of unrealised fixed assets. The proper balance of the company's balance-sheet would not be disturbed by such a course of action. The company would be left with assets of sufficient value to meet the commitments shown on the liabilities side of its balance-sheet, including paid-up share capital. A company is not required by law to keep any part of ..... X X X X Extracts X X X X X X X X Extracts X X X X
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