Business Law (part 45)

"If the freedom of speech is taken away then dumb and silent we may be led, like sheep to the slaughter."

George Washington

Ownership of a Corporation (part B)

 by

 Charles Lamson

Kinds of Stock

In addition to the two classes of stock (common (common stock is a form of corporate equity ownership, a type of security. The terms voting share and ordinary share are also used frequently in other parts of the world; "common stock" being primarily used in the United States. They are known as equity shares or ordinary shares in the UK and other Commonwealth realms. - https://en.wikipedia.org/wiki/Common_stock) and preferred (a form of stock which may have any combination of features not possessed by common stock including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument - https://en.wikipedia.org/wiki/Preferred_stock)), stock comes in several different kinds. These include par-value stock, no-par-value stock, treasury stock, and watered stock.

Par-Value Stock

Stock to which face value, such as $25, $50, or $100, has been assigned and that has this value printed on the stock is par-value stock. Preferred stock usually has a par value. The law requires that when a corporation issues par-value stock in return for payment in money, property, or services, the par value of the stock must be equal in value to the money, property, or services. This relates only to the price at which the corporation may issue the stock to an original subscriber. It has no effect upon the price paid between a stock shareholder and a buyer thereafter. The price a buyer pays the shareholder ordinarily equals the market price, which may be more or less than the par-value. If a corporation sells par-value stock at a discount, the purchaser incurs liability to subsequent creditors of the corporation for the discount. 

No-Par-Value-Stock

Stock to which no face value has been assigned is no-par-value stock. A corporation may issue no-par-value stock at any price, although some states do set a minimum price, such as $5, for which it can be issued. Common stock may be either par-value or no-par-value stock.

Treasury Stock

If a corporation purchases stock that it has sold, this reacquired stock is referred to as treasury stock. When a corporation first offers stock for sale, less sales resistance may be encountered if the prospective purchaser can be assured that the corporation will repurchase the stock upon request. Treasury stock may also be reacquired by gift. The reacquired stock may be sold at any price fixed by the directors. Until the corporation resells it, no dividends can be paid on it nor can it be voted. 

Watered Stock

Stock issued as fully paid up, but paid with property of inflated values, is said to be watered stock. If someone conveys real estate actually worth $40,000 for stock having a par-value of $100,000, the stock is watered to the extent of $60,000. Watering stock may be prohibited outright, but in any case it cannot be used to defraud creditors. In the event of insolvency, the creditors may sue the original recipients of watered stock for the difference between the par-value and the actual purchase price. This may not be true of course, if the creditors knew the stock was watered. Although creditors are allowed these rights, most state statutes do not prohibit the watering of stock by corporations other than the public utility companies.

If a person pays for stock with overvalued real estate, the extent of the watering can be determined with reasonable accuracy. If a person pays in the form of patents, trademarks, blueprints, or other similar assets, the extent of the watering may be difficult to determine. 

Transfer of Stock

A stock certificate indicates the manner in which the stock may be transferred to another party. The owner may use a blank form on the back of the certificate in making a transfer. The signature of the previous owner gives the new holder full possession and the right to exchange the certificate for another made out by the corporation to the new owner. Whenever an owner transfers stock, the new owner should have the certificate exchanged for a new one showing the correct name so that the corporation's books will show the correct stockholders' names. Stockholders who are not registered do not have the rights and privileges of a stockholder and will not receive any declared dividends.

If a broker holds the stock and certificates have not been issued, the broker can transfer the stock at the written direction of the owner. Under the Uniform Stock Transfer Act, the unregistered holder of stock has a right to the distribution that represents a return of capital. As under common law, the unregistered holder has no right to any distribution that represents a share of the profits.

Stock Options

A stock option is a contract entered into between a corporation and an individual. The contract gives the individual the option for a stated period of time to purchase a prescribed number of shares of stock in the corporation at a given price. If a new corporation sells stock to the public at $2 a share, the individual having the option must also pay $2 but may be given 2, 5, or even 10 years in which to exercise the option. If a corporation succeeds, and the price of the stock goes up, the individual will of course want to exercise the option and buy at the low option price and then resell at the higher market price. If the corporation fails, the option does not have to be exercised. Existing corporations may give officials of the corporation an option to purchase a given number of shares of stock in lieu of a salary increase. If the market price of the stock rises, an official may make a capital gain by buying the stock, holding it for the required time, and selling it. The income tax on a capital gain may be considerably less than that on other income. This type of compensation may be more attractive to top management officials than a straight increase in salary, enabling a corporation to retain their services at a lower cost than with a salary increase. If the corporation makes stock available to all the corporation's employees, the option price may be less than the fair market value.

Dividends

The profits of a corporation belong to the corporation until the directors set them aside for distribution by declaring a dividend. Dividends may be paid in cash, stock, or other property.

A cash dividend usually can be paid only out of retained earnings with two exceptions. A cash dividend may be paid out of donated or paid-in surplus. Also, for corporations with depleting assets, such as coal mines, oil companies, lumber companies, and similar Industries, cash dividends may be paid out of capital.

Stock dividends may be in the corporation's own stock or in stock the corporation owns in another corporation. When in the corporation's own stock, they are usually declared out of retained earnings, but they can be paid out of other surplus accounts. A stock dividend of the corporation's own stock cannot be declared if the corporation has no surplus of any kind. Dividends also may be paid in the form of property that the corporation manufacturers, but this seldom happens.

The declaration of a dividend on either common or preferred stock depends almost entirely upon the discretion of the directors. The directors, however, must act reasonably and in good faith. This means minority stockholders can ask the court to require a corporation to declare a dividend out of surplus profits only when they clearly have a right to a dividend.

Once the directors declare a cash dividend, it cannot later be rescinded. It becomes a liability of the corporation the minute the directors declare it. A stock dividend, on the other hand, may be rescinded at any time prior to the issuance and delivery of the stock. 

*SOURCE: LAW FOR BUSINESS, 15TH ED., 2005, JANET E. ASHCROFT, J.D., PGS. 421-424*

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