A recent Delaware Court of Chancery case examines the nature of preferred stock. In Shintom Co., Ltd. v. Audiovox Corporation (pdf), Chancellor Chandler considers a claim that the Delaware General Corporation Law (§ 151(c)) "mandates that the holders of preferred stock must receive dividend rights." The plaintiff in this case (Shintom) argues that "because Audiovox Delaware’s preferred shares do not pay dividends, they are void as a matter of law." According to Chancellor Chandler, "This appears to be a question of first impression."
Section 151(c) reads as follows (emphasis added):
The holders of preferred or special stock of any class or of any series thereof shall be entitled to receive dividends at such rates, on such conditions and at such times as shall be stated in the certificate of incorporation or in the resolution or resolutions providing for the issue of such stock adopted by the board of directorsif any as hereinabove provided, payable in preference to, or in such relation to, the dividends payable on any other class or classes or of any other series of stock, and cumulative or noncumulative as shall be so stated and expressed. When dividends upon the preferred and special stocks, if any, to the extent of the preference to which such stocks are entitled, shall have been paid or declared and set apart for payment, a dividend on the remaining class or classes or series of stock may then be paid out of the remaining assets of the corporation available for dividends as elsewhere in this chapter provided.
Shintom wanted to read the first part of that section -- "The holders of preferred or special stock of any class or of any series thereof shall be entitled to receive dividends" -- as requiring dividends, but Chancellor Chandler refers to the "plain language" of § 151(c) to reject this reading: "Had the drafters of § 151(c) intended for mandatory dividends, they certainly would not have left open the very real possibility that the rates could be set at zero." This must be the right answer. It is certainly the answer I would have given to a client, and I suspect that this is a case of first impression because the issue isn't really very close.
Chancellor Chandler offers an extended discussion of the word "shall" in § 151(c), and along the way, he provides some very quotable conclusions about the statute that are sure to arise in future cases. For example, he reaffirms the long-held notion that the terms of preferred stock in Delaware are entirely contractual:
The entirety of § 151 must be viewed as though it is discussing rights that exist between the corporation and preferred stockholders, rights that are found in the certificate of incorporation and are enumerated on the stock certificate.
Even so, Chancellor Chandler notes, preferred stock "must have some preferred right over the common, otherwise the stock is considered illusory. See Telvest, Inc. v. Olson, 1979 WL 1759, at *5; Moran v. Household Intern., Inc., 500 A.2d 1346, 1352 (Del. 1985)." The most common preferential rights are dividends and liquidation preferences, and either will suffice to create a preferred stock.
With this backdrop, the word "shall" in § 151(c) does not function "as a command that forces every corporation to offer dividend rights, but as a guarantee that if it does offer dividend rights, it must fix the rates, conditions and terms of payment in the resolution authorizing the stock issuance or in the corporation’s charter so as to afford stockholders an enforceable contract right."
Just in case you still have doubts, Chancellor Chandler analyzes the second sentence of § 151(c):
The relevant portion of § 151(c) states: “When dividends upon the preferred and special stocks, if any, to the extent of the preferences to which such stocks are entitled, shall have been paid or declared and set apart for payment, a dividend on the remaining classes or series of stock may then be paid out of the remaining assets of the corporation available for dividends as elsewhere in this chapter provided.” (Emphasis added). Shintom’s counsel argued that the “if any” language actually refers to a situation where the corporation decides to pay dividends, not whether the corporation may choose to grant dividend rights. As stated above, however, I conclude that the “if any” language is the Legislature’s acknowledgment that there may be preferred and special stocks that do not grant dividend rights.
Again, I think this must be the right answer. Shintom might have argued that "if any" was a reference to "special stocks," not to dividends. While this is plausible, the phrasing -- "preferred and special stocks, if any" -- links preferred and special stocks in a way that "if any" would seem to refer to both if it referred to either.
Thanks to Francis Pileggi for the tip.
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1. Posted by Jack Chin on May 18, 2005 @ 13:38 | Permalink
Why can't the "if any" language refer to the circumstance when no dividends are due under the terms of the preferred stock (for example, if there are insufficient profits?) Doesn't this decision imply that there can be common and preferred stock with no dividends payable at all, ever? Maybe that's permissible, but to a non-corporate person, it seems odd. If it means that "preferred stock" can receive no dividends when the common stock does, then the decision seems to conflict with the statute, because the first sentence must mean something.
2. Posted by Eric Goldman on May 18, 2005 @ 14:40 | Permalink
Weird litigation. In practice, we had always taken it for granted that dividends were not mandatory for preferred. We thought the 151 language meant that preferred is just first in line for any declared dividends. Nice to know that this was right.
3. Posted by Gordon Smith on May 18, 2005 @ 14:58 | Permalink
Jack: "Doesn't this decision imply that there can be common and preferred stock with no dividends payable at all, ever?"
Yes, that's right. I don't see the conflict with the first sentence. Chancellor Chandler is reading the first sentence to mean: "the preferred is entitled to whatever dividends are specified in the charter or resolution, and that amount can be zero."
He reads the "if any" sentence to mean, "If the preferred is entitled to a dividend preference and that preference amount has been paid, then ..."
Note that two concepts are in play in Eric's comment. Dividend preference and entitlement to dividends. There is no requirement in corporate law that every equity security be entitled to receive dividends. That was the holding here.
Even if preferred is entitled to dividends, it need not have a dividend preference. That is, dividends to the preferred are not required to be paid first, unless the charter requires that result.
4. Posted by francis pileggi on May 18, 2005 @ 19:07 | Permalink
good summary and discussion of the case.
5. Posted by Robert Schwartz on May 19, 2005 @ 12:21 | Permalink
I find the Chancellor's decision unsurprising and correct. However, do not try this at home. IIRC, if preferred stock does carry a coupon there is real risk that it will create original issue discount and your world will come to an end. Do not issue no dividend preferred stock without consulting a Tax Guru.
6. Posted by Lawrence Cunningham on May 19, 2005 @ 21:33 | Permalink
Compare Toms v. Cooperative Management Corp., 741 So.2d 164 (Louisiana 1999) (state corporation law statute providing that directors “shall state an amount to be allocated to stated capital” for newly-issued shares held to require directors to assign something other than $0.00 to stock issued without par value).
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