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May 26, 1950


The opinion of the court was delivered by: GALSTON

The jurisdiction of the court is based on diversity of citizenship, the plaintiff being a resident of this district and the defendant a resident of the State of Illinois.

The plaintiff is the owner of two hundred shares of 6% noncumulative convertible series A preferred stock of the par value of $ 100 each, and on behalf of himself and all other holders of the like issue of stock seeks judgment against the defendant:

(1) Decreeing that dividends on said issue for each of the years 1937 to 1947, inclusive, were fully earned; that there were sufficient earnings or surplus in each of said years to pay the dividends, and that accordingly such dividends are due and payable to the holders of said stock.

 (2) Decreeing that the dividend arrears for the eleven years amounted to $ 66 per share, making a total of $ 12,306,162.

 (3) That while such dividend arrears and any current dividends, or any future dividends as they accrue remain unpaid, no dividend may be declared or paid on the common stock of the defendant.

 The Illinois Central Railroad Company was incorporated under the laws of the State of Illinois in the year 1851. It owns and operates a railroad with its principal terminus in the City of Chicago, and serves some of the most important industrial areas of the United States. It has investments in properties of many subsidiaries, together forming what is known as the Illinois Central System. This system operates more than 6,000 miles of railroad.

 As at December 31, 1947, the funded debt of the defendant, including equipment obligations, first and other mortgages on properties, collateral trust obligations, debenture obligations, was the sum of $ 229,595,970.

 The common stock, as at that date, par value $ 100, issued and outstanding, totaled 1, 357, 994 shares.

 The preferred stock, 6% $ 100 par value, noncumulative convertible, issued and outstanding as at the same date, totaled 186,457 shares.

 The issue of the preferred stock was pursuant to resolutions of the annual meeting of the stockholders held April 19, 1922, and the meetings of the board of directors held April 27, 1922, October 10, 1923 and September 20, 1925.

 The stock certificate of the 6% noncumulative convertible preferred stock, Series A, contains the following provisions: 'The preferred stock shall be preferred both as to dividends and assets and shall be entitled to receive out of the surplus or net profits of the Company, in each fiscal year, dividends at such rate or rates, not exceeding seven per cent, per annum, as shall be determined by the Board of Directors in connection with the issue of the respective series of said stock and expressed in the stock certificates therefor, before any dividends shall be paid upon the common stock, but such dividends shall be non-cumulative. No dividends shall be paid, declared, or set apart for payment on the common stock of the Company, in any fiscal year, unless the full dividend on the preferred stock for such year shall have been paid or provided for. Whenever in any year the dividend paid on such preferred stock is less in amount that the full dividend payable on all such stock outstanding, the dividends paid shall be divided between the series of such stock outstanding in the same proportion to the aggregate sums which would be distributable to the preferred stock of each of such series if full dividends were paid thereon.'

 Dividends for the years 1922 to 1931, inclusive, were paid on said preferred stock at the rate of 6%. However, commencing in 1932 no dividends were declared or paid on the preferred stock until 1948, at which time payment of 6% dividend on the preferred stock was declared, 3% of which was paid on May 15, 1948, and 3% on September 1, 1948. In 1949 the full 6% dividend was also declared and paid. So far as dividends on the common stock are concerned, payment was suspended on October 27, 1931. No dividend on such stock was thereafter declared until January 18, 1950, when after providing for payment of the dividend on the noncumulative preferred stock for 1950, the board of directors declared a dividend of $ 1.50 on the common stock payable July 1, 1950.

 It is agreed that the amount of money which would have been needed to pay 6% dividends on the outstanding 186,457 shares of the noncumulative convertible preferred stock, Series A, for the period from January 1, 1937 to December 31, 1947 is the sum of $ 12,306,162, which is the aggregate of $ 1,118,742 per annum for those years.

 It is the contention of the plaintiff that since the net income each year from 1937 to 1947, inclusive, exceeded the annual dividend requirement on the noncumulative preferred stock, such dividend should have been declared and paid for each of said years. The plaintiff argues that under the terms governing the issue of dividends on such stock, the directors had no discretion with respect to the declaration of such dividends, and during the years in question the payment of such dividends was mandatory. The plaintiff also contends that even assuming that the directors had discretion, they abused their discretion by failing to declare and pay such dividends. Thirdly the contention is made that assuming the right to a preferred dividend was not mandatory, and that the directors did not then abuse their discretion in failing to declare and pay preferred dividends, nevertheless such dividends for the years 1941 through 1947 were merely deferred, and must now be paid or provided for before any dividends may be paid on the common stock.

 The defendant's position is that whether dividends on the 6% noncumulative convertible preferred stock, Series A, should be declared and paid in any year rests wholly in the sound business judgment and discretion of its board of directors.

 Moreover, though admitting that the consolidated net income of the defendant in each of the years 1937 to 1947, inclusive, exceeded $ 1,118,742, such income in each year was either expended consistently with defendant's lawful duties to its stockholders and to the public to promote safe and efficient maintenance of its property and service, or, in the judgment of its board, was required for corporate purposes other than the payment of such dividends.

 Similarly in respect to plaintiff's allegations respecting the total surplus of the defendant as reported in its annual reports to stockholders, the defendant contends that such surpluses represented in major part investments made in previous years in defendant's business and physical properties which could not be declared or paid out as dividends; and also that any cash or temporary cash investments in those items were in the sound business judgment of its directors required for defendant's corporate purposes other than the payment of dividends.

 The defendant also alleges that though cash and temporary cash investments at December 31, 1947, as set forth in its 98th annual report, were $ 71,502,494.79, in the judgment of its board of directors that sum was required at that time to meet early maturing funded debt obligations amounting to $ 229,595,970, issued and assumed by the defendant, and for maintenance of its property and service and working capital.

 Among the affirmative defenses set up is that relating to the solution of the railroad's problems attending its heavy early maturing funded debt, which at December 31, 1937 amounted to $ 367,588,175. Notes to the Reconstruction Finance Corporation amounting to $ 35,185,000, maturing in 1939 were extended to 1944. When application was made in 1942 for an order for extension of said notes, the defendant was obliged, in order to procure such extension, to meet various conditions imposed by the Reconstruction Finance Corporation. Among them was the requirement that the loan be reduced on or before January 1, 1943 by $ 10,000,000; that the extended note be secured by collateral having a market value of not less than 135% of the aggregate principal of the notes; and that the railroad company provide an annual sinking fund, payment in cash or its equivalent in bonds, of not less than 1% of the principal of said note. Finally, as very intimately related to the issues in this case, the railroad company was required to agree that as long as it remained indebted to the Reconstruction Finance Corporation it would never declare nor pay any dividends on any class of its capital stock unless written consent of the corporation was first obtained. Recommendation was also made by the Reconstruction Finance Corporation that the railroad reduce its fixed charges; and with that understanding the Corporation agreed that from time to time, with the prior approval of the Interstate Commerce Commission, it would lend the railroad money to assist the railroad company in purchasing its bonds at a discount. It developed that during the year 1943, because of the increase in the defendant's revenues, due to wartime conditions, the defendant was able to make payment of its notes to the Reconstruction Finance Corporation, and thus comply with a request made in 1942 by Jesse Jones, the head of the Reconstruction Finance Corporation.

 Then in the fall of 1945 the board of directors of the railroad company undertook additional steps to solve the problem entailed by the existing heavy funded debt, and authorized the issuance, on November 1, 1945, of an invitation for tenders on $ 53,794,000, face amount of the defendant's non-callable bonds due in the years 1950, 1951 and 1952. Pursuant to this invitation bonds were tendered in the amount of approximately $ 32,000,000 face amount, but at such prices that the defendant could accept only $ 15,464,000 face amount, which were purchased at an average of 95%, or at a cost of $ 14,757,536.75.

 In December 1945 the directors formulated a plan to issue two classes of new bonds, Series A, to the extent of $ 49,443,000, and Series B, to the extent of $ 35,000,000 by which the A bonds were to be offered in exchange for outstanding non-callable bonds in a similar face amount. The Series B bonds were to be sold to the public, and the proceeds used to redeem refunding bonds outstanding in the amount of $ 35,000,000. On January 16, the stockholders authorized the creation of a new mortgage for the purpose of securing the proposed new bonds. However, less than 50% of the principal amount of the exchangeable bonds were deposited despite the fact that there was an increase in the interest rate of bonds from 3 1/8 % to 3 1/4 %. Consequently on June 21, 1946 the defendant was obliged to abandon that plan.

 Among other problems facing the directors was the claim by the State of Illinois, involving a potential liability for charter taxes of from $ 30,000,000 to $ 50,000,000. In December 1946, in settlement in part, the defendant paid $ 5,955,175 to the State of Illinois, and finally, on May 20, 1948, an additional sum of $ 171,848.66.

 The plaintiff waived, during the course of the trial, such allegations of the complaint as purported to charge the defendant with having been dominated in its corporate acts by the Union Pacific Railroad Company as the holder and owner of 28.94% (98,270 shares of the preferred stock and 268,700 shares of the common stock) of the outstanding stock of the Illinois Central, and that Wayne A. Johnston was elected at the instance of the Union Pacific Railroad Company.

 The plaintiff's proofs consisted solely of exhibits based on the company's annual reports as interpreted by the witness Holtz. The plaintiff then rested.

 The defendant called as its witnesses a group which, in the order in which they appeared on the stand, included the Chairman of its Board of Directors, Eugene Stetson; the Vice President in Charge of Accounting, Robert E. Connolly; a Vice President and General Counsel, Vernon W. Foster; directors King and Gaylord; George W. Bovenizer, an investment banker; Charles A. Mottier, Vice President and Chief Engineer, and Wayne A. Johnston, its President.

 Testimony, together with the defendant's main exhibits, was directed to the basic issue of discretion and sound judgment exercised by the board of directors of the road at all times. *fn1" During the period from 1931 to 1936, which was generally regarded in the financial and industrial world, and indeed by people of the United States generally, as a depression period, the railroad was operated at a loss of roughly $ 3,500,000 in 1931 and 1932, earned $ 158,906 in 1933, showed losses of approximately $ 3,000,000 in 1934, and of $ 9,800,000 in 1935, and a profit of $ 864,603 in 1936. These ...

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