Cunningham Estate

149 A.2d 72, 395 Pa. 1, 1959 Pa. LEXIS 587

• Court: Supreme Court of Pennsylvania
• Decided: January 12, 1959
• Docket: Appeals, 222, 223, and 228,
• Status: Published

Opinions

Opinion by

Mb. Justice Benjamin B. Jones,

These appeals involve a reexamination of the century-old “Pennsylvania Buie of Apportionment” with particular reference to its application to certain stock distributions made to a trustee¹ by the General Electric Company and the Gulf Oil Corporation.

Edith B. Cunningham died testate, October 11, 1933. By will she created a trust of her residuary estate and appointed as trustee the Fidelity-Philadelphia Trust Company. Under this trust two-thirds of the income is payable to testatrix’ son, John B. Cunningham, for life and, upon his death, two-thirds of the principal is to be paid to his issue him surviving in equal shares per stirpes; one-third of the income is payable to John B. Cunningham’s daughter, Mary E. Cunningham, for life and, upon her death, one-third of the principal is to be paid to her issue her surviving in equal shares per stirpes. Both the life tenants are presently alive. Mary E. Cunningham, unmarried, is the only living issue of John B. Cunningham. The trust further provides that, if John B. Cunningham should die without issue him surviving, the income is payable to certain named brothers and sisters of testatrix during their lives, and, upon the death of the survivor of them, the principal is to be paid in three equal shares, with stipulations as to its use, to the University of Pennsylvania, The American Oncologic Hospital of the City of Philadelphia and the Board of National Missions of the Presbyterian Church, U.S.A. All testatrix’ named brothers and sisters are now dead.

The trustee filed its third account in order that the Orphans’ Court of Philadelphia could pass upon various questions relating to the possible apportionment to the income beneficiaries of gains on the sale of certain securities and on stock distributions received by the trustee from certain corporations.

The questions now presented relate exclusively to the trustee-purchased common stock of the General Electric Company and the Gulf Oil Corporation, both of which corporations have distributed additional stock to their stockholders, including the trustee. These questions are: (1) are these stock distributions subject to apportionment between principal and income to any extent? (2) if so, how should such apportionment be effected? The court below² decided that these stock distributions were subject to apportionment in a manner more fully described herein. These appeals ensued.

A brief recitation of the factual background of each stock distribution is requisite to an understanding of the problem.

General Electric Company

On two occasions³ during the term of the trust the trustee purchased a total of 150 shares of the no par common stock of this company. The aggregate cost was $6,935.57, and the aggregate book value as of the purchase dates was $2,403.50. In 1954 the corporation “changed and converted” its common stock by exchanging the old no par value stock which had a stated value of $6.25 per share for common stock having a par value of $5.00 per share and issuing three new shares in exchange for each old share, thus increasing the trust’s holdings from 150 to 450 shares. To effect this distribution required $15.00 in the capital stock account for the three new shares issued (the difference between the par value of the three new shares [$15.00] and the stated value of the old share [$6.25] being $8.75). The new par value was arrived at by two corporate steps: (1) a “write-down” of the stated value of each old share from $6.25 to $5.00, thus making $1.25 of capital available for the “additional” new shares and (2) by transferring the balance required — $8.75—from “reinvested earnings” (earned surplus) to the capital stock account.

The court below held this “change and conversion” constituted an apportionable event and that 87%% of the “additional new shares” — i.e. the ratio of the amount transferred from “reinvested earnings” to the capital stock account to the adjusted amount of capital realized from both the transfer and “write-down”— was subject to apportionment.

Gulf Oil Corporation

On two occasions⁴ the trustee purchased a total of 125 shares of the common stock of this corporation, each share having a par value of $25.00. The total cost was $8,736.50 and the aggregate book value as of the purchase dates was $8,997.96. In 1951 the Gulf Oil Corporation authorized the distribution — which it termed a dividend — to its shareholders of one additional share of the common stock of the corporation for each share of its outstanding stock, thus increasing the trust’s holdings from 125 to 250 shares. To provide the new par value [$25.00] of the additional share the corporation transferred upon its books $18,549 per share from earned surplus to the capital stock account and $6,451 per share from paid-in surplus to the capital stock account.

The court below held that, inasmuch as the corporation had transferred on its books from earned surplus to capital stock account approximately 75% of the par value of the new shares, therefore approximately 75% of the new shares received by the trustee was subject to apportionment.

Atlhough General Electric refers to the distribution as a “change and conversion”, while Gulf Oil refers to it as a “stock dividend”, it is important to note that both transactions were essentially the same in that the par value of the new stock issued was in part supplied by a transfer of earnings to the capital stock account. In both instances, the life tenants rely upon this capitalization and alleged removal of earnings as a source of future dividend payments as justification for an apportionment. This fact was recognized by all the judges of the Orphans’ Court of Philadelphia County and we believe by all counsel, all of whom agreed on the facts although differing as to the results which legally flowed therefrom.

Our initial inquiry must be to determine whether these stock distributions constitute events or occasions which, under the “Pennsylvania Rule of Apportionment”, require an apportionment of such stock between the life tenants and the remaindermen. The basis of the ruling in the court below was that whenever corporate earnings are capitalized to support the issuance of new shares of stock, whether such shares be issued in exchange for outstanding shares, or as a dividend on outstanding shares, an apportionment must be made.

This inquiry begins with the recognition that the “Pennsylvania Rule of Apportionment” has been abrogated by the Uniform Principal and Income Act of May 3, 1945,⁵ subsequently repealed but substantially re-enacted by the Principal and Income Act of July 3, 1947,⁶ as to all trusts created subsequent to the dates of such legislation. The Rule’s application is now limited to trusts created before the effective dates of such statutes: Crawford Estate, 362 Pa. 458, 67 A. 2d 124; Warden Trust, 382 Pa. 311, 115 A. 2d 159; Steele Estate, 377 Pa. 250, 103 A. 2d 409; Pew Trust, 362 Pa. 468, 67 A. 2d 129; 99 U. Pa. L. Rev. 864, 865. In view of this legislative declaration of a public policy contra the Rule shall we, as to trusts created prior to such legislation, extend the Rule beyond the point it had reached when such legislation became effective?⁷ 7 Shall that which had not been judicially determined to be an' occasion or event for apportionment be now held such occasion or event, or shall the application of the old Rule be restricted to only those situations judicially recognized as apportionable events or occasions prior to the legislative abrogation of the Rule?⁸

An examination of all the decisions of this Court on the subject of apportionment indicates that the Rule was applied and apportionment decreed only in the following situations: “(1) the distribution by the corporation of an extraordinary cash or stock dividend, or (2) the liquidation of the corporation, or (3) a sale of the stock by the trustees, or (4) the issuance of stock rights [citing cases].”: Jones Estate, 377 Pa. 473, 476, 105 A. 2d 353, 354. In Buist’s Estate, 297 Pa. 537, 147 A. 606, we said: “The life tenant is not entitled to any division until (1) the increased value is declared as a cash dividend, or (2) distributed in the form of a stock dividend, or (3) the affairs of the [corporation] are wound up so that assets are distributed to those entitled to receive them, or (4) there is a sale of this stock so that the connection of shareholder is entirely severed”.⁹ See also: Crawford Estate, 362 Pa. 458, 461, supra. In no instance has this Court expressly restricted the Rule’s application to these specific situations. However, in point of fact, we have never applied the Rule to other than the above enumerated situations. Moreover, we have expressly held that a merger even though it involves a capitalization of earnings and the issuance of new and different par value shares was not an apportionable event: Jones Estate, 377 Pa. 473, 105 A. 2d 353. The instant stock distributions present a situation of first impression in this Court.

The auditing judge found the existence of an apporfcionable event by concluding that when this Court said that a “stock dividend” constituted an “apportionable event”, we meant that “when new stock is issued to existing stockholders and the new stock is supported by a- capitalization of earnings, that to the extent of such capitalization of earnings, there is an apportion-able event”. The Court en banc regarded the stock distribution “in the nature of stock dividends” because earnings had been capitalized and held that “an apportionment is to be made whenever, independent of a corporate merger, earnings or earned surplus are capitalized to support, in whole or in part, the issuance of new shares . . .” The court below concluded the Rule’s application to the instant stock distributions did not extend the Rule since the transactions could be considered “stock dividend” events.

The basic question is whether an apportionment must be made whenever corporate earnings are capitalized to support the issuance of new shares.

The rationale of the Pennsylvania Rule from its very inception (Earp’s Appeal, 28 Pa. 368, 374) has been that a life tenant should not be deprived of earnings which were accumulated since his ownership merely because the corporation decided to declare them in some form other than cash. The logical and essential fairness of apportioning a stock dividend or stock rights which represent accumulated earnings is readily apparent and sustainable. Furthermore, it is entirely consistent to hold that an apportionable event takes place when the stock is sold or the corporation liquidated because such events represent the only and last opportunity for a life tenant to share in any corporate earnings accumulated since creation of the trust. To hold, however, that any capitalization of corporate earnings followed by a stock issuance or stock exchange is an event requiring an apportionment marks a far departure from the original concept which gave birth to the Rule.

To warrant an apportionment it must be shown that there are corporate earnings (since acquisition of the stock) plus an apportionable event. We have treated as apportionable only the following events: the liquidation of the corporation,¹⁰ the distribution of a stock dividend,¹¹ the distribution of an extraordinary cash or scrip dividend,¹² sale of the stock itself,¹³ the sale or the exercise of rights to subscribe to stock¹⁴, and the distribution of extraordinary • stock dividends even though such dividends are paid in stock of another corporation.¹⁵

In Jones Estate, 377 Pa. 473, 105 A. 2d 353, we were presented with the problem of whether an apportion-able event arose from the merger of the Union Trust Company of Pittsburgh and the Mellon National Bank and Trust Company plus the concomitant capitalization of over $58,000,000 of earned surplus. Prior to that merger the Union Trust Company had a capital stock account of $1,500,000 and an earned surplus of $108,-500,000 and the Mellon Bank had a capital stock account of $7,500,000 and an earned surplus of $40,000,-000. To accomplish the merger the capital stock account of the new corporation was increased to $60,100-000 from $1,550,000 and it became necessary to transfer from earned surplus to the capital stock account $58,550,000. For each share of stock held the Union Trust Company stockholders received 8 shares of stock of the new corporation and the stock of the Mellon National Bank and Trust Company held by Union Trust Company was cancelled. The earnings- capitalized were less than the earnings accumulated by the Union Trust Company between the date of decedent’s death and the merger date. Our denial of the occurrence of an apportionable event was not based simply on the existence of a merger as the court below indicated. Appellant’s argument in Jones Estate, supra, was exactly the same as the position taken by the Orphans’ Court in the instant case, namely that “the true test of whether an apportionable event occurs in a given situation is whether the transaction results in the capitalization of any earnings in one form or another. If such is the result, there must be an apportionment”. We rejected this contention and in our determination that no apportionable event had occurred we said: “While there was no capitalization of surplus ... in that merger [Buist’s Estate, 297 Pa. 537] that fact cannot change the principle there established”, (p. 478).

Present day economic conditions, particularly in the corporate field, present a drastic contrast to the economic conditions in existence at the inception of and during the formative years of the Rule, and corporate practices plus multiplication and extension of taxes has made the application of the Rule even more difficult and often unworkable. The complexities, the uncertainties, and the difficulties which are inherent in the application and administration of the Rule have too often in these modern times created confusion, injustices and glaring inconsistencies. The essential fairness and equity of the Pennsylvania Rule was beyond question.¹⁶ The basis for its rejection and abandonment by legislation is the fact that changes in corporate practice have, in many instances, rendered unworkable the Rule. In recent years the ingenuity of corporate management, seeking to achieve various ends such as broadening or enhancing the market for its stock, effect tax savings, etc., has produced a complexity of corporate transactions which involve the transfer on corporate books of earnings, earned surplus, etc., from one account to another. Earnings, under modern corporate practice, no longer retain the simplicity of meaning of the earnings considered by this Court in Earp’s Appeal, supra, and other decisions.¹⁷

The general rule in a corporation-shareholder relationship was well expressed in Green et al. v. Philadelphia Inquirer Company et al., 329 Pa. 169, 175, 196 A. 32: “Stockholders are not entitled to the earnings as such of a corporation. A corporation is an entity separate and distinct from its stockholders and a dividend declaration is necessary to create in the stockholder any ownership or other property right in the earnings. Where the owner of corporate stock dies leaving a will whereunder the stock is given to one person for life, with remainder to another person or persons, he does not thereby create any larger property rights as a stockholder in any of his beneficiaries than he himself had”. The Eule is an exception to this general rule in that the stockholder is considered to have an ownership in the earnings of the corporation accumulated since the date of the creation of the trust and possession by the stockholder of such earnings awaits only the happening of an apportionable event.¹⁸ The sole justification for this exception must rest upon the theory that that which corporate management labels as reinvested earnings, earnings, earned surplus, etc., is actually corporate income Avhich has been earmarked and set aside solely for eventual distribution to the shareholders. Under modern corporate methods, however, such accounts may be and are set up for various and sundry reasons, for example, to cover future expansion, cost of equipment, future contingencies or reserves for losses in business, etc. and that which is labelled “earnings” may and often does represent items other than income, such as capital gains.

The Rule holds that upon distribution of corporate earnings in one of the above mentioned forms, a life tenant is entitled to receive the earned net income of a corporation which has accumulated since the stock was acquired, except where it is necessary to preserve the intact value of the principal. The Rule’s application requires that the fiduciary, upon the happening of an apportionable event, determine the source from which distribution was made, whether such source consists of actual earnings or profits of the corporation earmarked solely for distribution to stockholders and how much of said earnings or profits have accumulated since the creation of the trust.¹⁹

The fiduciary is required in each instance to make a full and complete study and investigation of the entire corporate background and to scrutinize all the corporate transactions at the cost of considerable time and trust money. Even if the fiduciary performs such a duty its eventual decision too often lias to be made on an arbitrary and speculative basis. To include the present type of stock distributions within the orbit of apportionable events would add chaos to an already chaotic condition. Whether we label the new stock distributions as being “in the nature of stock dividends” or not, to hold that they constitute apportion-able events would be to extend the Rule’s application, an extension clearly without justification in the present state of the law.

This Court, which created the Rule, should be the first to acknowledge its unworkability, inconsistencies and inequities in many instances under modern economic conditions. Parental defense of a child is justified only to the extent that the child’s conduct is defensible. The language of the Supreme Court of New Jersey in Estate of Henry Fera, supra, 142 is most apposite: “It is indeed small consolation to either the life cestui or remainderman that equity has apparently been served, if the ultimate result of the endeavor is to substantially reduce the net gain available to the trust estate and the final determination of the respective equities of the parties is founded as much upon speculation and guesswork as it is upon fact. These factors together with the increasing complexity of corporate structures and accounting methods, which progressively makes more difficult and costly an accurate analysis of the past financial history of a corporation, are practical realities that persuade us to reject the [Rule] . . .”

The practicalities of the situation, the historical restriction by our Court of the application of the Rule to certain specific situations other than are here present, and the legislative enunciation of a public policy contra the Rule preclude its extension to cover the instant stock distributions.

Decree reversed. Costs on the estate.

2 The court below was divided 3-2. One judge dissented on the mechanics of the apportionment while another judge dissented on the ground that the stock distributions did not constitute apportion-able events.

3 100 shares were purchased February 21, 1939 and 50 shares March 8, 1951.

4 100 shares were purchased March 14, 1949 and 25 shares March 5, 1951.

5 P.L. 416, 20 PS §3471.

6 P.L. 1283, 20 PS §3470.

7 See: Estate of Henry Fera, 26 N.J. 131, 139 A. 2d 23, wherein the Supreme Court of New Jersey was faced with substantially the same problem.

8 Amicus curiae aptly argues that “while the legislature cannot turn back the clock”, it can “stop the clock”.

9 Waterhouse’s Estate, 308 Pa. 422, 428, 429, 162 A. 295.

10 Connolly’s Estate (No. 1), 198 Pa. 137, 47 A. 1125; McKeown’s Estate, 263 Pa. 78, 106 A. 189.

11 Earp’s Appeal, 28 Pa. 368.

12 Nirdlinger’s Estate (No. 1), 327 Pa. 160, 193 A. 33; Mandeville’s Estate, 286 Pa. 368, 133 A. 562; Flaccus’s Estate, 283 Pa. 185, 129 A. 74.

13 McKeown’s Estate, supra; Nirdlinger’s Estate, 290 Pa. 457, 139 A. 200.

14 Hostetter’s Trust, 319 Pa. 572, 181 A. 567; Jones v. Integrity Trust Company et al., 292 Pa. 149, 140 A. 862.

15 Barnes Estate, 338 Pa. 555, 12 A. 2d 912.

16 “it is a rule designed to achieve as nearly as possible exact justice between the successive interests, irrespective of the difficulty of its application”: Estate of Henry Fera, supra, p. 136.

17 “There is a serious question as to whether corporate earned surplus should have the sacred meaning ascribed to it by the great mass of apportionment decisions. Instead, there should be room for the concept that accumulated surplus is less an income retention than it is a vehicle to replace capital equipment at constantly increasing costs, thereby assuring future income which otherwise might be lost to the life tenant”: Legal, Tax and Accounting Aspects of Fiduciary Apportionment of Stock Proceeds — The Non-Statutory Pennsylvania Rules, Cohan and Dean, 106 U. of Pa. L. Rev. 157, 205, 206.

18 “One difficulty with the argument is that no court has been willing to follow it to its ultimate logical conclusion, and to treat the earnings of the corporation as for all iDurposes income to the shareholders. The rule is generally applied only when the earnings are distributed by the corporation among the shareholders in the form of a dividend”: Scott on Trusts, Vol. 2, §236.3, p. 1302 (1939).

19 “Any trustee who has to decide such a question must indeed be puzzled. If he tries to make a decision on his own account, he will have to spend a great deal of time and some trust money in getting the corporate history of the organization issuing the stock . . . and taking the advice of experts. He runs the danger of making- a decision which may lay him open to liability at the hands of either L [life cestui] or R [remaindermen]. In cases of importance, litigation to get the opinion of the court will be almost a certainty. No precedents will help in deciding such a question. Each case will be different. The gain to both life cestui and remainder-men may well be eaten up in court costs and lawyers’ fees.” 4 Bogert, Trusts and Trustees, §824, p. 273 (1948).