[405]*405OPINION.
Teammell:
The material facts pertinent to the issue in this proceeding are not in dispute. Shortly after its organization petitioner issued certificates in the amount of $500,000 which it denominated “ Class A Preferred Stock,” and thereafter retired the amount of $10,040.90 thereof, leaving outstanding during the taxable years here involved, the amount of $489,959.10. At the same time, it issued other certificates in the amount of $150,000, which it designated “ Class B Preferred Stock.” Petitioner contends that these certificates represented invested capital, as defined in section 320 (a) of the Revenue Act of 1918, and that in the computation of its invested capital for the taxable years 1918 and 1919, it is entitled to have included therein the total outstanding balance of $639,959.10. Respondent contends that the certificates in question represented borrowed capital, and that under the express provisions of section 326 (b) of the Revenue Act of 1918, the entire amount must be excluded from invested capital. A single issue of law is thus raised for consideration here.
Were these certificates, when issued, certificates of stock in fact or were they in effect certificates of indebtedness ? Petitioner designated them as “ Class A Preferred Stock ” and “ Class B Preferred Stock ” respectively, and as we said in the Appeal of Kentucky River Coal Corporation, 3 B. T. A. 644, it is not lightly to be assumed that parties have given an erroneous name to their transaction. However, it is well settled that mere designation can not, in the last analysis, be a controlling factor in the determination of the true nature of an instrument. In the Appeal of I. Unterberg & Co., 2 B. T. A. 274, we held that the name by which an instrument is denominated, either on its face or on a corporation’s books, is not conclusive as to its [406]*406character, and that its true nature will be determined by looking to its terms and legal effect. A mortgage creditor, although denominated a “ preferred stockholder ” is a mortgage creditor nevertheless, and interest is not changed into a “ dividend ” by calling it a dividend. Burt v. Rattle, 31 Ohio St. 116. Again, the Supreme Court of Ohio, in considering a similar situation, said: “ ‘ The question is not, what did the parties call it, but what do the facts and circumstances require the Court to call it ? ’” Miller v. Ratterman, 47 Ohio St. 141; 24 N. E. 496. We must, therefore, in order to determine the true character of these certificates, examine into the terms of the contracts under which they were issued, and consider the legal effects flowing therefrom. Since it appears that the contracts are materially different, the two classes of certificates will be discussed in their alphabetical order.
The holder of a corporation’s stock, whether common or preferred, can not by virtue of the ownership of such stock, be a creditor of the corporation. He can not be both a creditor and a debtor. And so the holders of the certificates under consideration were either stockholders of the corporation or creditors. This leads us then to inquire first into the fundamental difference between a stockholder and a creditor, or between certificates of stock and certificates of indebtedness. Obviously the difference lies in the relationships existing between the holders of the certificates and the corporation, which are fixed by the terms of the bertificates or the contracts under which they are issued. A stockholder of a corporation is one who has invested money or money’s worth in the enterprise, with hope or expectation of receiving income or profit from the operations of the company. If the venture be successful, he receives his proportionate part of the profit; otherwise, he may lose the amount of his investment represented by the certificates of stock. A creditor of a corporation is one who has loaned to it money or its equivalent, usually for compensation or interest, at a fixed rate, to be repaid at a designated time or in a designated manner. The creditor is in no wise concerned in the profits of the corporation or its property. If it prospers, he is not benefited thereby, and if it suffers a loss, he is still entitled to the return of his loan in accordance with the contract. The stockholder risks his money in the enterprise. The creditor assumes no such risk.
In Warren v. King, 108 U. S. 389, the Supreme Court said, at page 399:
Creditors may resort to th'e body of their debtor’s property for interest as well as principal. But these holders of preferred stock are limited, for any income or interest, to net earnings.
# * & & 9 $ >£
His [the stockholder’s] chance of gain, by the operations of the corporation, throws on him, as respects creditors, the entire risk of the loss of his share [407]*407of the capital, which must go to satisfy the creditors in case of misfortune. He can not be both creditor and debtor, by virtue of his ownership of stock.
In Miller v. Ratterman, supra, the Supreme Court of Ohio states the difference between a preferred stockholder and a creditor as follows:
The question in the case is whether the certificates are certificates of stock or certificates of indebtedness. * * *
Tlie relation of a holder of preferred stock is, in some of its aspects, similar to that of a creditor; but he is not a creditor save as to dividends, after the same are declared. Nor does he sustain a dual relation to the corporation. He is either a stockholder or a creditor. He cannot, by virtue of the same certificate, be both. If the former, lie takes a risk in the concerns of the company, not only as to dividends and a proportion of assets on the dissolution of the company, but as to statutory liability for debts in case the corporation becomes insolvent. If the latter, he takes no interest in the company’s affairs, is not concerned in its property or profits as such, but his whole right is to receive agreed compensation for the use of the money he furnishes, and the return of the principal when due. Whether he is the one or the other depends upon the proper construction of the contract he holds with the company.
What is preferred stock? By preferred stock is to be understood stock which entitles the holder to receive dividends from the earnings of the company before the common stock is paid a dividend from such earnings. In other words, it is stock entitled to .dividends from the income or earnings of the corporation before any other dividend is paid. Cook on Corporations, 8th ed. vol. 1, § 267.
When the principles above set forth are applied to the provisions of the contract embodied in and under which the Class A certificates were issued, it is at once apparent that they are not, as they purport to be, certificates of preferred stock, but are in effect certificates of indebtedness. The holders of those certificates were absolutely and at all events entitled to have returned to them the total sum of $500,000, to be paid in sums of $5,000, at the rate of $3.50 for each 1,000 feet of timber sold or cut, and the corporation obligated itself to cut sufficient timber to pay for at least one million feet per month, subject only to the happening of certain contingencies beyond the control of the corporation.
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[405]*405OPINION.
Teammell:
The material facts pertinent to the issue in this proceeding are not in dispute. Shortly after its organization petitioner issued certificates in the amount of $500,000 which it denominated “ Class A Preferred Stock,” and thereafter retired the amount of $10,040.90 thereof, leaving outstanding during the taxable years here involved, the amount of $489,959.10. At the same time, it issued other certificates in the amount of $150,000, which it designated “ Class B Preferred Stock.” Petitioner contends that these certificates represented invested capital, as defined in section 320 (a) of the Revenue Act of 1918, and that in the computation of its invested capital for the taxable years 1918 and 1919, it is entitled to have included therein the total outstanding balance of $639,959.10. Respondent contends that the certificates in question represented borrowed capital, and that under the express provisions of section 326 (b) of the Revenue Act of 1918, the entire amount must be excluded from invested capital. A single issue of law is thus raised for consideration here.
Were these certificates, when issued, certificates of stock in fact or were they in effect certificates of indebtedness ? Petitioner designated them as “ Class A Preferred Stock ” and “ Class B Preferred Stock ” respectively, and as we said in the Appeal of Kentucky River Coal Corporation, 3 B. T. A. 644, it is not lightly to be assumed that parties have given an erroneous name to their transaction. However, it is well settled that mere designation can not, in the last analysis, be a controlling factor in the determination of the true nature of an instrument. In the Appeal of I. Unterberg & Co., 2 B. T. A. 274, we held that the name by which an instrument is denominated, either on its face or on a corporation’s books, is not conclusive as to its [406]*406character, and that its true nature will be determined by looking to its terms and legal effect. A mortgage creditor, although denominated a “ preferred stockholder ” is a mortgage creditor nevertheless, and interest is not changed into a “ dividend ” by calling it a dividend. Burt v. Rattle, 31 Ohio St. 116. Again, the Supreme Court of Ohio, in considering a similar situation, said: “ ‘ The question is not, what did the parties call it, but what do the facts and circumstances require the Court to call it ? ’” Miller v. Ratterman, 47 Ohio St. 141; 24 N. E. 496. We must, therefore, in order to determine the true character of these certificates, examine into the terms of the contracts under which they were issued, and consider the legal effects flowing therefrom. Since it appears that the contracts are materially different, the two classes of certificates will be discussed in their alphabetical order.
The holder of a corporation’s stock, whether common or preferred, can not by virtue of the ownership of such stock, be a creditor of the corporation. He can not be both a creditor and a debtor. And so the holders of the certificates under consideration were either stockholders of the corporation or creditors. This leads us then to inquire first into the fundamental difference between a stockholder and a creditor, or between certificates of stock and certificates of indebtedness. Obviously the difference lies in the relationships existing between the holders of the certificates and the corporation, which are fixed by the terms of the bertificates or the contracts under which they are issued. A stockholder of a corporation is one who has invested money or money’s worth in the enterprise, with hope or expectation of receiving income or profit from the operations of the company. If the venture be successful, he receives his proportionate part of the profit; otherwise, he may lose the amount of his investment represented by the certificates of stock. A creditor of a corporation is one who has loaned to it money or its equivalent, usually for compensation or interest, at a fixed rate, to be repaid at a designated time or in a designated manner. The creditor is in no wise concerned in the profits of the corporation or its property. If it prospers, he is not benefited thereby, and if it suffers a loss, he is still entitled to the return of his loan in accordance with the contract. The stockholder risks his money in the enterprise. The creditor assumes no such risk.
In Warren v. King, 108 U. S. 389, the Supreme Court said, at page 399:
Creditors may resort to th'e body of their debtor’s property for interest as well as principal. But these holders of preferred stock are limited, for any income or interest, to net earnings.
# * & & 9 $ >£
His [the stockholder’s] chance of gain, by the operations of the corporation, throws on him, as respects creditors, the entire risk of the loss of his share [407]*407of the capital, which must go to satisfy the creditors in case of misfortune. He can not be both creditor and debtor, by virtue of his ownership of stock.
In Miller v. Ratterman, supra, the Supreme Court of Ohio states the difference between a preferred stockholder and a creditor as follows:
The question in the case is whether the certificates are certificates of stock or certificates of indebtedness. * * *
Tlie relation of a holder of preferred stock is, in some of its aspects, similar to that of a creditor; but he is not a creditor save as to dividends, after the same are declared. Nor does he sustain a dual relation to the corporation. He is either a stockholder or a creditor. He cannot, by virtue of the same certificate, be both. If the former, lie takes a risk in the concerns of the company, not only as to dividends and a proportion of assets on the dissolution of the company, but as to statutory liability for debts in case the corporation becomes insolvent. If the latter, he takes no interest in the company’s affairs, is not concerned in its property or profits as such, but his whole right is to receive agreed compensation for the use of the money he furnishes, and the return of the principal when due. Whether he is the one or the other depends upon the proper construction of the contract he holds with the company.
What is preferred stock? By preferred stock is to be understood stock which entitles the holder to receive dividends from the earnings of the company before the common stock is paid a dividend from such earnings. In other words, it is stock entitled to .dividends from the income or earnings of the corporation before any other dividend is paid. Cook on Corporations, 8th ed. vol. 1, § 267.
When the principles above set forth are applied to the provisions of the contract embodied in and under which the Class A certificates were issued, it is at once apparent that they are not, as they purport to be, certificates of preferred stock, but are in effect certificates of indebtedness. The holders of those certificates were absolutely and at all events entitled to have returned to them the total sum of $500,000, to be paid in sums of $5,000, at the rate of $3.50 for each 1,000 feet of timber sold or cut, and the corporation obligated itself to cut sufficient timber to pay for at least one million feet per month, subject only to the happening of certain contingencies beyond the control of the corporation. And it was further provided that should there be a failure for as much as two months upon the part of the corporation to set aside the sum of $3.50 for payment to the holders of such certificates, the holders might assume control of the corporation, a right frequently granted to bondholders similarly circumstanced. The holders of these Class A certificates, as such, had no interest in the profits of the corporation or in its property, as such. If the corporation made large profits, or no profit, or suffered a loss, it did not affect their rights, which were restricted to the payment to them of the amount of money stated, and in the manner set out, in [408]*408the contract. They risked nothing thereby in the business ventures of the corporation. They assumed no risk not assumed by an ordinary creditor, and the payment of the money was not required to be made out of the income or profit, but the sum of $3.50 was to be paid for each 1,000 feet of timber sold or cut until the full amount of the certificates had been refunded.
But it is argued by the petitioner that, because the rights of the certificate holders were subordinated to those of the holders of mortgage bonds, this determined the status of the former as preferred stockholders. While it is true that this is an attribute of preferred stock, imputed by law, whether or not expressly provided by contract, it is also a provision often applied to issues of bonds, whereby one issue or series of bonds is given preference over another. The legal effect of such a provision in the case of bonds is merely to create a restricted indebtedness. This question was before us in the Appeal of I. Unterberg & Co., supra, in connection with which we said:
Examining the terms and effect of the instrument, we are unable to hold it to be a certificate of stock. It is evidence of a restricted indebtedness. The fact that the principal amount is subordinated to the claims of general business creditors is not sufficient to warrant this Board’s determination that it is stock for the purpose of invested capital * * *.
Applying the principle of invested capital, it is questionable whether these amounts were in fact risked in the enterprise. They were payable at maturity, subject to the claims of general creditors. They were an obligation of the corporation, enforcible in all respects except that the general creditors might insist that the assets should not be impaired below the amount of their claims. Thqy were of a lower degree than such claims, and yet fixed in amount and time so as to distinguish them from stock * * *.
We hold the instruments in question to represent borrowed capital, and hence that the amount thereof may not be included in invested capital.
It is our opinion that the certificates herein designated by the petitioner as “ Class A Preferred Stock ” were in the nature of certificates of indebtedness, which represented borrowed capital, and may not therefore be included in its invested capital under section 326 (b) of (.he Revenue Act of 1918. Accordingly, the action of respondent i excluding said certificates to the amount of $489,959.10 is approved.
An examination of the provisions of the contract relating to the Class B certificates discloses that they possessed all of the essential qualities of preferred stock. The fact that both the Class A and Class B certificates contained no provision for the payment either of interest or preferred dividends is not material in determining whether they represented invested or borrowed capital for tax purposes. The contract provided that the Class B certificates should be retired at par when, if and as the earnings of said corporation should permit, but prior to any dividend distribution or declared benefit on common shares. It further provided that said certificates should be retired by dividends to be paid in amounts of not less than $5,000 at [409]*409one time, and should be paid from time to time as the directors might determine. Thus, it is clear that if the corporation had no net income or earnings out of which dividends could be declared, the holders of the Class B certificates, would receive no payments, since no other provision therefor was made, with the exception that after the Class A certificates had been fully retired from the timber, the residue of the proceeds, if any, from that asset, might be applied to retiring the Class B certificates. This, however, was also a contingency. The holders of the Class B certificates were not entitled at all events to the return of the amount represented by the certificates, either within a definite time or in a designated manner free of contingencies. The return of their money was dependent Upon the success of the enterprise. We conclude, therefore, that the Class B certificates represented shares of preferred stock, which may properly be regarded as a part of the capital structure of petitioner. The amount of these certificates in the sum of $150,000 should be reflected in the computation of petitioner’s invested capital for each of the years involved herein. The action of respondent in excluding the Class B certificates from the invested capital of petitioner is disapproved.
Judgment will be entered on 15 days’ notice, under Rule 50.
Milliken did not participate.
Aeundell, Phillips, Smith and Trussell dissent.