MEMBERSHIP IN CORPORATIONS
Sec. 74. Membership in nonstock corporations. Where the
corporation is a nonstock company, membership is regulated by the
by-laws. 1 No one can become a member of such corporation, ex-
cept in compliance with the method prescribed by the by-laws.
Sec. 75. Membership in stock companies. Membership in a
stock corporation is acquired by a contract with the corporation;
this membership is evidenced by a certificate showing ownership of
shares of stock. The right to membership may be acquired by a
stock subscription before the corporation is created, or by a pur-
chase of shares of stock from the corporation after it is organized,
or by a transfer of shares from some person who owns the stock.
Sec. 76. Capital stock and capital. Much confusion has arisen
by reason of the different meanings attributed to the terms "capi-
tal stock" and "capital." Strictly speaking, from the viewpoint of
the corporation, its capital stock is the expressed equity of the
stockholders in corporate assets resulting from their investments
before the latter have been influenced by profits or losses. It
should equal the amount of money, services, and property paid in
or subscribed by the stockholders for the purposes of carrying on
the corporate business. It is sometimes said to be the sum fixed in
the corporate charter. This amount always remains the same un-
less changed by an amendment of the charter. However, if the
subscriber pays more than par to the corporation for his stock, the
excess is usually credited to capital surplus rather than capital
The term capital stock has also been used to mean the represent-
ative interest of the shareholders in the total assets of the corpora-
tion, measured by its tangible and intangible property, franchise,
and good will.
The term capital stock, as used in some statutes for taxation pur-
poses, refers to the total value of the property owned by the cor-
poration. The first of these three views is generally considered to
express correctly the true meaning of capital stock.
On the other hand, capital means the net assets of the corpora-
tion, including not only the original investment but also all gains
and profits realized from the conduct of the corporate business.
ir The American Live Stock Commission Company v. The Chicago Live Stock
Exchange, 1892, 143 111. 210; p. 703.
278 BUSINESS ORGANIZATIONS CORPORATIONS
For example, if a corporation is incorporated with a capital stock
of $50,000, fully paid, and it makes a profit of $20,000, which is kept
in the business and is not distributed as dividends, it has a capital
of $70,000. Its capital stock, however, is the $50,000 originally
placed in the business.
Sec. 77. Shares of stock. A share of stock is said to consist of
a number of rights which the owner acquires in the corporation.
These rights are primarily three in number: the right to share in
profits, to participate in the control of the corporation, and to re-
ceive a portion of the assets at time of dissolution. A share of
stock is representative of an investment made in the corporation,
but it gives the holder no right to share in the active management
of the business. A share of stock is personal property and in its
nature a chose in action, even though the corporation owns nothing
but real estate. Like other personal property it falls under the
Statute of Frauds, which requires a memorandum in writing to evi-
dence a sale or a contract to sell that involves more than a certain
sum of money. Like other personal property a share passes, on the
death of a shareholder, to his legal representatives and not to the
By statute, a share of stock is subject to execution and attach-
ment by creditors of the stockholder. The statutes usually pro-
vide the method by which a levy and a sale of a share of stock for
the payment of debts are made. A levy or an attachment by a
sheriff of a share of stock is not good, unless the sheriff seizes actual
possession of the certificate.
Sec. 78. A certificate of stock. A certificate of stock is a writ-
ten evidence of the ownership of a certain number of shares of stock
of a corporation. The certificate itself is not property, but is
merely evidence of the stockholder's right in the corporation. The
certificate of stock shows upon its face the character and the num-
ber of the shares which it represents and the method of transfer,
and may state a part of the contract existing between the share-
holder and the corporation, or the other shareholders. A sub-
scriber often becomes a stockholder before the certificate is issued.
The certificate merely indicates that the corporation recognizes a
certain person as being a stockholder.
Sec. 79. Bonds and shares. A bond differs from a share of
stock in that it is an obligation of the corporation to pay a certain
sum of money in the future, at a fixed interest rate. It is generally
secured by a mortgage on the assets of the corporation. Thus, a
bondholder has a lien upon the assets of the corporation, whereas
a stockholder merely has a right to participate proportionately in
the assets of the corporation after all creditors have been paid. A
MEMBERSHIP IN CORPORATIONS 279
bondholder has no right to vote or to participate in the manage-
ment and control of a corporation, unless, upon insolvency, such
rights are given by contract; whereas a shareholder, in the absence
of contractual limitations, has a right to participate in the corpo-
There are certain contracts with corporations which are difficult
to classify. Is the holder of a preferred share of stock, which guar-
antees a dividend at a given rate and contains a promise of redemp-
tion at a given time but which carries no right to vote, a share-
holder or a creditor? Similarly, is a bondholder, whose bond draws
interest payable only out of profits, and who is subordinated to the
claims of general creditors in case of insolvency, and whose bond
gives the holder the right to vote in case interest payments are not
made, an investor in a corporation or a creditor? The law in regard
to these questions has not been made clear at the present time.
The answers are determined largely by the terms of the agreement.
Sec. 80. Stock warrants. A stock warrant is a certificate which
gives to the holder thereof the right to subscribe for a given num-
ber of shares of stock in a corporation at a stated price. It is usu-
ally issued in connection with the sale of other shares of stock, or
of bonds, although the law of some states permits the issuance of
stock warrants entirely separate and apart from the sale of other
securities. Usually the warrants are transferable, although in some
cases they are personal only. The option to purchase contained in
the warrant may or may not be limited as to time. The warrant
has value and can readily be sold on the market only when the op-
tion to purchase is at a price which is below the market price of the
stock covered by the stock warrant.
Sec. 81. Stock subscriptions before incorporation. Where a
number of persons subscribe for stock in a corporation to be formed
in the future, there is generally no contract between the various
subscribers. Unless provided otherwise by statute, it stands as a
mere continuing offer by each subscriber to the corporation to take
stock when the corporation is formed, and may be revoked at any
time before acceptance by the corporation. 2 In some jurisdictions
a subscription paper signed by a number of persons, prior to the
formation of a corporation, constitutes a binding, irrevocable offer
to the corporation, by reason of the mutual promises of the parties,
and amounts to a subscription when the corporation is formed.
Subscriptions for shares are often made subject to the happening
of certain conditions precedent. The subscriber agrees to take
8 Hudson Real Estate Co. v. Tower et al., 1892, 166 Mass. 82, 30 N.E. 465; p. 704.
280 BUSINESS ORGANIZATIONS CORPORATIONS
shares conditioned upon the promoter's securing certain other per-
sons to take shares, or upon a certain number of shares being sub-
scribed. Until these conditions are met, the subscriber neither is
liable for his subscription nor does he become a stockholder. How-
ever, if creditors of the corporation and third parties will be preju-
diced thereby, the nonperformance of these conditions will not re-
lieve the subscriber of liability. Unless conditions precedent are
written in the subscription contract, they cannot be used as a de-
fense by the subscriber in an action by the corporation.
Certain conditions are inherent in the subscription contract.
The subscriber will not be liable unless the corporation is completely
organized as a de jure corporation, the full amount of the capital
stock has been subscribed in absence of an express agreement to
the contrary, and the purpose, articles, and by-laws of the corpora-
tion are as originally stated. Conditions express or implied are
often waived by the subscriber who, with knowledge of the nonper-
formance, participates in stockholders' meetings, pays part or all of
his subscription, or acts as an officer or director of the corporation.
A distinction must be made between a subscription on a condi-
tion and a conditional delivery of a subscription contract. In an
action against the subscriber, oral evidence may be admitted that
the subscription contract was conditionally delivered and that in
absence of the happening of the condition no subscription contract
was to come into existence. Such evidence, however, cannot be
introduced to show that the subscription was a conditional one if
other parties have been misled thereby.
Sec. 82. Subscriptions after incorporation. A subscription to
stock of a corporation already in existence is a contract between the
subscriber and the corporation, and such a contract may come into
existence by reason of an offer either made by the corporation and
accepted by the subscriber or made by the subscriber and accepted
by the corporation. If the corporation opens subscription books
and advertises its stock, it is seeking for an offer to be made by the
subscriber. The corporation may, however, make a general offer
to the public, which may be accepted by the subscriber in accord-
ance with the terms of the general offer.
One must exercise care in distinguishing between a present sub-
scription to stock, by which contract the subscriber immediately
becomes liable as a stockholder, and a contract to purchase stock.
Where the contract is for the purchase of stock, the purchaser does
not become a stockholder until p, certificate of stock has been de-
livered to him. Upon the breach of such contract and the tender
of the stock certificate by the corporation, recover is limited to dam-
ages for failure to purchase. Under a present subscription con-
MEMBERSHIP IN CORPORATIONS 281
tract, however, the subscriber is liable upon his promise to pay for
the full amount of the stock subscribed, even though the corpora-
tion has not tendered the stock certificate.
An underwriter's contract to place a certain block of stock, or,
if unable to dispose of it, to purchase it himself, is not a subscrip-
tion contract. Such an underwriter may, however, be held liable
for as much of the stock as he guaranteed to dispose of but was un-
able to place. For his services in this connection, the underwriter
receives a certain commission on stock sold.
Kinds of Stock
Sec. 83. Common stock. Common stock is the simplest type
of corporate stock, and entitles the owner to share in the profits and
assets of the corporation in proportion to the amount of common
stock he holds. Such a stockholder has no advantage, priority, or
preference over any other class of stockholders.
Sec. 84. Preferred stock. Preferred stock is stock which has
a prior claim to dividends, or to assets on dissolution, over other
classes of stock. The most important right given to a preferred
stockholder is the right to receive a certain specified dividend, al-
though the earnings are not sufficient to pay a like dividend to com-
mon stockholders. If the dividend is guaranteed, such preferred
stock is sometimes called guaranteed stock. Guaranteed stock,
however, does not mean a guaranty of the payment of dividends.
It merely means that dividends will be paid if they are earned.
Preferred stock may be provided for by the charter; but, if no
provision is made for the issuance of preferred stock by the charter
or statute, such stock cannot be issued without the unanimous con-
sent of the common stockholders.
Preferred stock may be cumulative or noncumulative. If the
certificate of the preferred stock evidencing the contract provides
that the preferred shares shall be entitled to a dividend of a certain
per cent annually when earned, and that the arrears, if any, in one
year or more, are payable out of the earnings of the subsequent
years, the dividends are said to be cumulative. If the dividends
are to be paid out of current profits only, the preferred stock is said
to be noncumulative. If nothing is said about the payment of the
dividends, the stock is cumulative, and preferred dividends and all
arrears thereon must be paid before a dividend is declared on com-
mon stock. 3 Whether preferred stock is cumulative or noncumula-
tive usually depends upon the statute or the contract on the face
of the certificate of stock.
Fidelity Trust Co. et al. v. Lehigh Valley Ry. Co., 1906, 215 Pa. 610, 64 Atl. 829;
282 BUSINESS ORGANIZATIONS CORPORATIONS
Preferred stock may be participating or nonparticipating. If
the preferred stock is given the right to share in dividends equally
with other classes of stock, after the payment of the preferred divi-
dends, it is generally designated as participating preferred stock. 4
Such participating preferred stock is entitled to dividends, however,
only after the common stock has had an equal dividend for the cur-
rent year. If, however, it is limited in its dividend to a fixed
amount, it is designated as nonparticipating preferred stock. The
term "participating preferred stock" is also used to designate a pre-
ferred stock which gives a preference in the assets on dissolution
and liquidation of the corporation, and assures the holder a future
right to share with other classes of stock in the assets which remain
after all stock has been fully satisfied on the original investment.
To determine whether preferred stock has equality in the participa-
tion in dividends with other classes of stock, after the payment of
its fixed dividend, it is necessary to examine not only the contract
evidenced by the stock certificate but also the articles of incorpora-
tion, the by-laws, and the statute. In the absence of an agreement,
preferred stock has no preference in corporate assets at dissolution.
Sec. 85. Watered stock. Watered stock is stock which has
been issued as fully paid, when in fact its full par value has not been
paid in money, property, or services. 5 The capital stock of a cor-
poration represents the total par value of all the shares of the cor-
poration, and the public has a right to assume that the capital stock
has all been paid in full, so that the corporation will have assets
sufficient to meet liabilities equal to its capital stock. If stock is
issued in excess of the actual assets in money value of the corpora-
tion, it is said to be watered stock, and original holders of such
stock are liable to creditors for its par value.
In suits by creditors against stockholders to force payment on
watered stock, it is maintained by many jurisdictions that the capi-
tal stock is a "trust fund" for the payment of the corporate debts
and that the law implies a promise by the original stockholders to
pay their stock in full when called upon by the creditors.
Another basis upon which creditors seek recovery against holders
of such stock is called the "holding out" theory. Under this doc-
trine the right of creditors to compel the holders of bonus stock to
pay for it, contrary to their actual agreement with the corporation,
rests not upon an implied contract or upon any trust fund doctrine
but simply upon the ground of fraud. This right applies only to
those creditors who have relied upon the stock as representing ac-
tual capital paid in ; therefore, payment cannot be enforced against
4 Scott v. Baltimore & Ohio Ry. Co. et al., 1901, 93 Md. 475, 49 Atl. 327; p. 706.
'Handley v. Stutz, 1891, 139 U.S. 417, 35 L. ed. 227; p. 707.
MEMBERSHIP IN CORPORATIONS 283
stockholders in favor of those creditors who became such before the
bonus stock was issued. In either case, only the original purchaser
of the stock is liable. One who acquires it in good faith from the
original stockholder has no additional liability.
Sec. 86. No par stock. The statutes of some states provide
that a corporation may issue stock with no par value, the value of
the stock being determined by its sale value in the open market.
Stockholders and the public will not be injured by this type of
stock, because there is no holding out that the stock has any par-
ticular face value, and all persons dealing in such stock are under
a duty to investigate the corporation's assets and its financial con-
ditions. Stock with no par value represents on its face what pro-
portionate part it is of the total assets of the corporation, but does
not indicate the monetary value of the share. The law usually
permits the directors to determine what portion of the amount re-
ceived from the sale shall be credited to the capital stock account
and how much, if any, shall be credited to capital surplus.
Sec. 87. Treasury stock. Treasury stock is that which has
been issued by the corporation for value and returned by gift or
purchase to the corporation, or to trustees for the corporation to
sell. It may be sold below par and the proceeds returned to the
treasury of the corporation for working capital. It differs from
stock originally issued below par, in that the purchaser is not liable
for the difference between par and the sale price. It may be sold at
any price the company sees fit.
Transfer of Stock
Sec. 88. Method of transfer. A share of stock is personal
property and the owner has a right to transfer his stock, just as he
may transfer any other personal property. It is a marketable com-
modity and is bought and sold daily on the market. A share of
stock is generally transferred by an indorsement and delivery of the
certificate of stock. In the absence of statute a share may be trans-
ferred or assigned by a bill of sale or by any other method that will
pass title to a chose in action or other intangible property. When-
ever a share of stock is sold and a stock certificate issued, the name
of the owner is entered on the stock book of the corporation. In a
small corporation the secretary of the corporation is capable of han-
dling all transfers of stock and the canceling and reissuing of new
certificates. This method, however, is inadequate in large corpo-
rations where the business of transferring stock has become enor-
mous and complicated. For the purpose of meeting this situation
transfer agents are now established and employed by corporations.
The transfer agents transfer stock, cancel old certificates, issue new
284 BUSINESS ORGANIZATIONS CORPORATIONS
ones, prepare and keep up to date the names of the stockholders of
the corporation, distribute dividends, mail out stockholders' no-
tices, and perform many of the functions normally performed by a
corporation secretary. The New York Stock Exchange rules pro-
vide that corporations listing stock for sale must maintain a trans-
fer agency and registry, operated and maintained under the rules
of the Stock Exchange ; similar rules are necessary for stock listed
on the New York Curb Market. The registrar of stock is an agent
of the corporation whose duty is to see that no stock certificates are
issued in excess of the authorized capitalization of the corporation.
For every share of stock transferred the old certificate must be can-
celed and a new certificate issued.
The transfer of stock is an assignment, and in order to make a
complete transfer a novation is necessary. A novation is executed
when the old stock certificate is surrendered and canceled and a
new certificate issued to the transferee and his name entered on the
corporate stock book by the corporation through the transfer agent.
Consequently, there are two distinct steps necessary to make a per-
fect transfer of the stock.
First, the certificate is assigned by the transferor to the trans-
feree by the transferor's signing his name in a blank provided on
the back of the certificate, and delivering it to the transferee. Sec-
ond, the transferred certificate is delivered to the corporation or
transfer agent and the corporation enters upon the corporate stock
transfer book that the transferee has acquired the stock, after
which recording the corporation issues a new certificate of stock,
certifying that the newly recorded stockholder owns the specified
amount of stock. The corporation then cancels the old certificate
As between the transferor and the transferee, the registration of
the transfer is not necessary. As between the stockholder and the
corporation, a registration is necessary, in order that the corpora-
tion may know who is entitled to the rights of a stockholder. Be-
tween the transferor and the transferee, an assignment of stock
may be made by a simple delivery of the certificate without writ-
ing, by a formal assignment on a separate sheet of paper, or by a
formal assignment accompanied by power of attorney authorizing
a person to sign the corporation transfer book and record the trans-
fer. Stock may be transferred by the transferor as collateral se-
curity, and under such circumstances an assignment on a separate
sheet of paper is the usual method.
Many states have adopted what is known as the Uniform Stock
Transfer Act. In the main, it provides for the method of transfer
MEMBERSHIP IN CORPORATIONS 285
indicated above, the transfer of a certificate from the transferor to
the transferee constituting a valid and complete transfer of the
shares of stock between the parties without a register of the trans-
fer upon the books of the corporation.
Sec. 89. Limitation upon the right of transfer. The right to
transfer freely one's share in the ownership of the business is in-
herent in corporate organization. It is one of those features of
corporate life which distinguishes it from a partnership. Unmind-
ful of this principle, "closed" corporations often attempt by agree-
ment or by-law to limit the group of potential purchasers. In this
effort they are only moderately successful. A corporate by-law
which provides that the shares of stock can be transferred only to
the corporation or to those approved by the board of directors is
unenforceable. It places too severe a restraint upon the alienation
of property. Society is best protected when property may be trans-
ferred freely from hand to hand. However, an agreement or a by-
law approved by all stockholders, to the effect that no transfer of
stock shall be made until it has first been offered to the other mem-
bers of the corporation, is generally enforced. Notice of the by-law
or agreement should be set forth in the stock certificate, since an in-
nocent purchaser without notice of the restriction on alienation
takes free from it.
Occasionally an officer of a corporation is appointed upon the
condition that he will purchase a certain amount of corporate
stock. The agreement usually stipulates that, upon the termina-
tion of his official relationship, he will resell the stock at a stipu-
lated price to the corporation. Such an agreement has generally
been enforced, although, if it is clear that the corporation promises
to purchase the stock, some courts suggest that the agreement is il-
legal. Since a corporation may acquire treasury stock only out of
surplus, an agreement to purchase when no surplus exists could
scarcely be enforced.
Sec. 90. Improper transfer. A certificate of stock to which
the shareholder's name has been forged is not negotiable. One who
purchases such a certificate gains no title to the shares represented
by it. 6 An interesting question arises in this connection when the
corporation issues a new certificate in reliance upon the forged in-
dorsement. An innocent purchaser of the new certificate clearly
has a claim against the corporation. Likewise, the stockholder
whose name was forged, not having lost title by the forgery, has an
action against the corporation to compel the restoration of his name
as a shareholder. The corporation finds its relief in recovery from
Continental Trust Co. v. Stump, 1926, 15 Fed.(2) 464; p. 708.
286 BUSINESS ORGANIZATIONS CORPORATIONS
the person who presented the stock for transfer. One who presents
a certificate for transfer warrants that all necessary indorsements
Under the Uniform Stock Transfer Act, a stock certificate which
has been indorsed in blank is substantially bearer paper. One in
possession of it may sell to an innocent purchaser and divest the
owner of title. A thief, a finder, or an agent in possession may
cause the owner to lose his title by an unauthorized sale. In those
states which have not adopted the Act, the weight of authority is
probably contra. They hold that a certificate of stock is nonne-
gotiable, thus giving the purchaser no better title than was held by
the person selling it to him.
Sec. 91. Transferor's liability. Stock which is being paid for
at the call of the board of directors may be sold before all of the
calls have been made. In such cases the purchaser is deemed to
have assumed responsibility for all future calls, and the transferor
is relieved of liability. In other words, as soon as the transfer is
recorded on corporate records, a novation has been consummated.
This is not true when the transfer is made to a financially irrespon-
sible person for the express purpose of eliminating the liability for
stock of doubtful value.
As to the calls made previous to the transfer, but which remain
unpaid at that time, the transferor remains liable. The liability of
the transferee in such a case doubtless depends upon his knowledge
or lack of knowledge of the unpaid calls. If the corporation issues
a certificate prior to the time when all calls are made, it should not
be marked "fully paid and nonassessable. " An innocent purchaser
of stock thus erroneously marked takes it free from any liability to
the corporation for unpaid calls.
Sec. 92. Right of transferee to dividends. Dividends on stock
belong to the person who is owner of the stock at the time the divi-
dends are declared. As to the corporation, the ownership of the
stock is determined by the stock register, and the dividends will be
paid to the person whose name appears upon the stock book. In
the absence of an agreement to the contrary, dividends declared
before a transfer of stock, although not payable until a future time,
belong to the transferor. 7 But dividends declared after the trans-
fer of the stock, although earned before the transfer, belong to the
transferee. However, by agreement between the transferor and
the transferee, upon notice to the corporation, the corporation must
pay the dividends in compliance with the agreement.
Dividends are often declared as of a certain date and payable to
stockholders of record as of a later date. In such cases, a transfer
7 Hyatt v. Allen, 1874, 56 N.Y. 553, 15 Am. Rep. 449; p. 709.
MEMBERSHIP IN CORPORATIONS 287
after declaration but before the record date, carries the dividends
to the transferee. There is also some authority to the effect that a
stock dividend passes to the transferee unless the contract of sale
provides otherwise. Dividends normally become a debt as of the
time they are declared, but stock dividends may be rescinded, ac-
cording to many courts, after they have been declared. Conse-
quently, in the case of cash dividends, the debt is owed to the
stockholder at the date of declaration, or record date, whereas in
reference to stock dividends no debt exists, since the new issue of
stock is transferred to the owner at the time it is issued.
Review Questions and Problems
1. What is the capital stock of a corporation? How is it represented?
Distinguish between it and the capital of a corporation.
2. What right does a share of stock give to the stockholder? Is it
personal or real property? What is the difference between a share of
stock and a certificate of stock?
3. A is a bondholder in the D Company. Under ordinary conditions
does he have any right to participate in the control of the business? Has
a bondholder any security for his bond?
4. The X Company has both preferred and common stock. The pre-
ferred stock is 7 per cent stock. The company declares a 7 per cent
dividend on the preferred stock and then declares a 10 per cent dividend
on the common stock. Under such conditions, have the preferred stock-
holders a right to demand 10 per cent?
5. A, along with a number of others, subscribes for stock in anticipa-
tion that a corporation will later be formed. Before incorporation takes
place, he notifies the incorporators that he withdraws his subscription.
May he legally do so? Suppose the subscription had been made after
6. What is meant by cumulative preferred stock? Would you rather
own cumulative or noncumulative preferred stock? Is the preferred
stockholder, in the absence of an agreement, entitled to a preference at
7. The X Company purchased an invention from A and paid for it by
the issuance of $100,000 of common stock. As a matter of fact the in-
vention was worth only $50,000, but the directors honestly believed that
it was worth $100,000. May the creditors recover an additional $50,000
8. What is no par stock? At what price may it be sold? What are,
9. How is stock usually transferred? Suppose the transferee fails to
have the transfer recorded until after a dividend is declared; does it af-
fect his right to the dividend? To whom would the company usually pay
such a dividend?
10. A became a transferee of sixty shares of stock in a corporation
288 BUSINESS ORGANIZATIONS CORPORATIONS
which issued its stock marked fully paid and nonassessable upon the pay-
ment of 70 per cent of its par value. Assuming that A knew the condi-
tions surrounding its issuance, is he liable to creditors in case of insol-
vency? Suppose he had been an innocent purchaser?
11. Explain the necessity for stock transfer agents and registrars.
12. A held a certificate of stock for twenty shares in X Company,
which was stolen. His indorsement was forged, and the certificate was
transferred to J5, an innocent purchaser. B obtained a new certificate
from the company in his name and sold it to H } an innocent purchaser.
What are the rights of A, H, and X Company?
13. Y Company on March 1 declared a cash dividend of 5%, payable
on June 1 to all stockholders of record on May 1. On April 10, A sold
ten shares of stock in Y Company to J5, although the transfer was not
recorded on the corporation's books until May 15. To whom will the
company pay the dividend? As between A and B, who is entitled to the