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Kern v. Chicago & Eastern Ill. R.r. Co.

JUNE 9, 1972.

PAUL J. KERN ET AL., PLAINTIFFS-APPELLANTS,

v.

CHICAGO & EASTERN ILLINOIS RAILROAD COMPANY, DEFENDANT-APPELLEE.



APPEAL from the Circuit Court of Cook County; the Hon. DONALD J. O'BRIEN, Judge, presiding.

MR. JUSTICE DRUCKER DELIVERED THE OPINION OF THE COURT:

Plaintiffs are two shareholders of Class A (preferred) Stock in the defendant Chicago & Eastern Illinois Railroad Company, hereinafter C & EI. They seek to compel the payment of a 1959 dividend of $2 per share which they claim should have been paid to persons who exchanged or had their Class A shares redeemed in 1965, or who still hold their shares. The trial court granted defendant's motion for summary judgment and plaintiffs appeal therefrom. The issues on appeal deal with the propriety of defendant's computations upon which it based its conclusion that there were no net earnings available for dividends on Class A shares for the year 1959.

The following facts are undisputed. Defendant C & EI was incorporated in Indiana in 1939 pursuant to reorganization proceedings supervised by the Interstate Commerce Commission, hereinafter ICC, and approved by Federal district court. As provided in its Articles of Incorporation, each share of Class A stock has a par value of $40 with an annual maximum dividend rate of $2. Dividends are cumulative but only to the extent that there are "net earnings available for dividends" in any given calendar year. As stated in the Articles of Incorporation:

"If in any year there shall be no net earnings available for dividends, or if the amount of net earnings available * * * shall be less than the maximum dividend requirement * * *, the deficiency shall not be made good in any subsequent year, nor shall any dividends accumulate with respect thereto."

During March 1965 the defendant made an offer to Class A shareholders to exchange each share of Class A stock for $40 in C & EI common stock plus $6 in dividends that had been "accumulated earned and unpaid" on the Class A shares. Seventy-five thousand, one hundred and five Class A shares were then outstanding. In July 1965 C & EI called the remaining outstanding Class A shares (39,712) for redemption. *fn1 The redemption price was $47.17; this figure represented the par value ($40) plus $7.17 in dividends that were then "accrued and unpaid" on the Class A shares. Under the terms of both the exchange offer and the redemption call, the C & EI computed that no dividends for the year 1959 had been "accumulated earned and unpaid" or "accrued and unpaid" on Class A shares. Defendant's records show that there was a deficiency in "net earnings available for dividends" on Class A stock for 1959 in the amount of $18,435.13.

Plaintiffs urge two theories in support of their claim for a $2 dividend for the year 1959. The first theory is based on the following: In 1959 defendant's wholly owned subsidiary, Chicago Heights Terminal Transfer Railroad Company, hereinafter CHTT, had net earnings of $392,193. CHTT's board of directors declared a $300,000 stock dividend; this sum was included in defendant's income statement and considered in computing the "net earnings available for dividends" on the Class A shares. CHTT placed $50,000 of the remaining $92,193 in its mandatory sinking fund; the other $42,193 was credited to its retained earnings account. The $92,193 in undistributed earnings of CHTT was not considered by C & EI as income nor as "net earnings available for dividends" on its Class A shares.

Plaintiffs contend that the undistributed 1959 earnings of CHTT should have been included in the income accounts of C & EI for 1959 thereby becoming "net earnings available for dividends" to Class A shareholders. They argue that their contention is supported by a proper construction of the defendant's Articles of Incorporation and the Uniform System of Accounts to which the Articles refer and also by generally accepted principles of accounting.

• 1 Although the issue was not briefed, it is clear that the law of Indiana, the state where defendant is incorporated, is controlling. See Guttman v. Illinois Central R. Co., 91 F. Supp. 285, aff'd 189 F.2d 927; Restatement (Second) of Conflicts § 304 (1971); 11 Fletcher Cyc Corp. § 5334 (perm. ed. rev. 1971).

• 2 Indiana, like Illinois, recognizes that the rights of preferred shareholders to dividends are contractual rights with the Articles of Incorporation serving as the terms of the contract. Rubens v. Marion-Washington Realty Corp., 116 Ind. App. 55, 59, 60, 59 N.E.2d 907; see Elward v. Peabody Coal Co., 121 Ill. App.2d 298, 308, 257 N.E.2d 500.

Defendant's Articles of Incorporation state that "net earnings available for dividends" to Class A shareholders are to equal the amount of "income available for contingent charges" (income less fixed charges less certain specified sums). Income available for contingent charges, in turn, is to be computed in accordance with the 1939 Uniform System of Accounts prescribed by the Interstate Commerce Commission for steam railroads. The 1939 Uniform System of Accounts provides that:

"Income accounts are those designed to show, as nearly as practicable, for each fiscal period * * * the returns accrued upon investments * * *. The net balance of income [or loss] shall be carried to Profit and Loss." (Emphasis supplied.)

Affidavits submitted by defendant in support of its motion for summary judgment showed that prior to and since 1959 CHTT has operated as a separate entity from defendant C & EI, having its own books, records and bank accounts. In 1959 the shareholders of C & EI and CHTT approved a plan to merge the two companies. However, in 1961 the ICC refused to approve the merger proposal. The decision, reported at 312 I.C.C. 564 (1961), stated that CHTT was to be maintained as a "distinct corporate entity." Additional affidavits submitted by defendant showed that officers of C & EI requested advice from the ICC as to the proper manner in which to account for the undistributed earnings of CHTT for 1959. A letter from the Director of the Bureau of Accounts for the ICC stated that:

"The Uniform System of Accounts does not require the transfer of earnings of a subsidiary to its parent, in the form of dividends or otherwise. Therefore, payment by a subsidiary to its parent of only those dividends duly declared by ...


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