These appeals come here upon seven questions certified by the Appellate Division relating to the sufficiency of the defenses set up in the answers. The main argument, however, has centered about the sufficiency of the complaint which apparently was passed over by counsel in the courts below. The Appellate Division in its opinion says: "As defendants have decided to reserve for the present all questions as to the sufficiency of the complaint, we assume that it states a cause of action of the general character indicated above." However, under the rule that an attack upon an affirmative defense enables the defendant to question the sufficiency of the complaint (Baxter v.McDonnell, 154 N.Y. 432; Manson v. Curtis, 223 N.Y. 313,319), the defendants in this court have raised this question and we must dispose of it before dealing with the answers.
The complaint alleges a cause of action against directors of the Interborough-Metropolitan Company and the Interborough Consolidated Corporation for fraudulently converting the funds of the corporations to their own use and advantage, and to the injury of the plaintiff, a bondholder, and others similarly situated. The Interborough-Metropolitan Company was a domestic corporation with an authorized capital of $155,000,000. At the times herein mentioned there was issued and outstanding $45,740,000 of preferred, and $93,262,192 of common stock. It had issued and outstanding $67,825,000 of bonds payable August 1, 1956, bearing interest from *Page 349 April 1, 1906. The Metropolitan Company was a holding company having large blocks of stock in the Interborough Rapid Transit Company, the Metropolitan Street Railway Company and the Metropolitan Securities Company. The latter two companies proved a loss. The Interborough Rapid Transit Company paid dividends, and the Interborough-Metropolitan Company received the dividends on its stock which it applied to the payment of the interest on its outstanding bonds. These bonds were issued under a trust agreement entered into on or about March 5, 1906, between the company and the Windsor Trust Company, a domestic corporation, as trustee. So far as the allegations in this complaint are concerned, the Metropolitan Company held one class of securities which were valuable and paid an income. This was the stock of the Interborough Rapid Transit Company. The dividends from this stock were sufficient to pay the interest on the bonds, and to accumulate each year a substantial amount to meet the principal of the bonds when due.
The capital of the Interborough-Metropolitan Company had become impaired to the extent of $80,000,000. Its capital stock, both common and preferred, amounted to $139,200,192 which plus the property received on the sale of the bonds made a total value of its property, or supposed property, of $206,827,192. The complaint alleges that its net assets were $52,559,948.54. To arrive at the net assets, it must, of course, be assumed that funds were set aside to pay the bonds. Therefore, adding this figure of $67,825,000 to the net assets, makes a total of $120,384,397.54, all the assets which the corporation had to offset its capital stock and bonded indebtedness. This left over $86,000,000 impairment of its capital, if we take the statements and allegations in the complaint. The complaint alleges that prior to the consolidation hereafter mentioned, the Interborough-Metropolitan Company had suffered an impairment of its capital to an extent upwards of $80,000,000. *Page 350
This was the condition which confronted the directors of the Interborough-Metropolitan Company. As a holding company it had sustained large losses through its ownership of the stock of the Metropolitan Street Railway Company and the Metropolitan Securities Company. It held the paying stock of the Interborough Rapid Transit Company, and this asset according to the allegations in the complaint was necessary to meet the interest and the principal on its trusteed bonds.
Under these circumstances, the directors were also faced with two provisions of law with which they are presumed to have been familiar. Section 28 of the Stock Corporation Law (Laws of 1909, chap. 61; Cons. Laws, ch. 59) provided: "The directors of a stock corporation shall not make dividends, except from the surplus profits arising from the business of such corporation, nor divide, withdraw or in any way pay to the stockholders or any of them, any part of the capital of such corporation, or reduce its capital stock, except as authorized by law." The directors of the Interborough Company had not declared dividends on its preferred stock for over seven years.
The capital stock of a corporation is intended as a fund for the ultimate security and payment of all its creditors, both present and future. A corporation has no right to declare dividends with a substantially impaired capital. The term "capital stock," in these provisions prohibiting the directors of a corporation from making dividends except from surplus profits of a corporation, or from dividing, withdrawing or in any way paying to the stockholders any part of the capital stock of the company, means the property of the corporation contributed by the stockholders or otherwise obtained to the extent required by its charter. The object of the provision was to prevent a withdrawal of the property which would reduce the value of its assets below the sum limited for its capital in its charter. When the property of the *Page 351 corporation exceeds that limit, the excess is surplus, which may be divided among the stockholders. (Williams v. Western UnionTelegraph Co., 93 N.Y. 162; Cottrell v. Albany Card PaperMfg. Co., 142 App. Div. 148.)
The complaint alleges the impairment of the capital stock of the Interborough-Metropolitan Company; the compliance of the directors with the law in refusing to pay dividends while the capital was impaired, and it then further alleges the facts which show how the directors got around these provisions of the law for the purpose of paying dividends to themselves instead of keeping the income as security for the bond creditors.
There was a domestic company, so the complaint alleges, known as the Financing and Holding Corporation, not engaged in business, with assets of $550 in cash. The directors determined to consolidate the Interborough-Metropolitan Company of $139,000,000 outstanding capital stock with this company under the name of the Interborough Consolidated Corporation. The consolidation was made, the new company having an authorized capital of $50,403,634.60. Consolidation was carried out under the forms prescribed by section 7 of the Business Corporations Law (Cons. Laws, ch. 4), which now provides and then provided that any two or more corporations organized under the laws of this State for the purpose of carrying on any kind of business of the same or of a similar nature may consolidate into a single corporation. The amount of the capital stock which must be fixed according to the agreement of consolidation is not to be larger in amount than the fair aggregate value of the property franchises and rights of such corporations. This consolidation statute did not provide the minimum below which the capital stock of the consolidated company could not be placed. The companies and the directors of the companies fixed on this figure of $50,000,000 which was not more than the net assets received from the two companies, which amounted to $52,559,397.54 from the Interborough-Metropolitan *Page 352 Company, and $550 apparently in cash from the Finance and Holding Corporation. This consolidated company, therefore, had about $2,000,000 more assets than capital stock — a surplus. This consolidation amounted in effect to a reduction in the capital stock of the Interborough-Metropolitan Company. The reduction could not be accomplished directly, for it was prohibited by section 62 of the Stock Corporation Law (Laws of 1909, chap. 61), which at that time read as follows: "Any domestic corporation may increase or reduce its capital stock in the manner herein provided, but not above the maximum or below the minimum, if any, prescribed by general law governing corporations formed for similar purposes * * * If reduced, the amount of its debts and liabilities shall not exceed the amount of its reduced capital." According to the figures above given, the debts and liabilities of the Interborough-Metropolitan Company did exceed the amount of the proposed reduced capital, and no reduction, such as proposed, could be made. However, the directors brought about a reduction under the consolidation statute which they now strongly urge was done in accordance with law, the terms of the statute, and, therefore, perfectly legal. As stated above, the new company, the Interborough Consolidated Corporation, with the same directors as those of the Interborough-Metropolitan Company and a few added who knew all the facts, received all the assets of the Interborough-Metropolitan Company, and also assumed under the law its debts and obligations. There was still outstanding and due from this new company, under the guidance, control and direction of the same directors the $67,000,000 bonds for which apparently the only security was the trust mortgage and the stock of the Interborough Rapid Transit Company, now turned over to the ownership of the consolidated company. What does the complaint allege that these directors did? Through the mere filing of papers these same men who had ceased to be *Page 353 directors of the Interborough-Metropolitan Company had now become directors of the same property under a new name, the Interborough Consolidated Company, handling the same assets and charged with a duty to provide for the payment of the same debts. The complaint alleges that they immediately divided up this alleged surplus of $2,000,000 assets among themselves, took the income from the dividends on the Interborough Rapid Transit stock and diverted it from security for the bonds and interest, and distributed it among themselves as stockholders, in the form of dividends upon stock of the new Interborough Consolidated Corporation. The complaint alleges that these directors both of the Interborough-Metropolitan Company and the Interborough Consolidated Corporation who are parties to this action, knew all the facts and consolidated these companies for the very purpose of wrongfully and fraudulently taking the assets of the Interborough-Metropolitan Company which should have been applied upon its outstanding bonds and distributing it among themselves in the form of dividends of the Interborough Consolidated Corporation.
It is now said that if all the allegations in the complaint are true, yet the consolidation being authorized by the Business Corporations Law, prevents a recovery; that as the forms of the statute have been complied with, the law will not look beyond these to the cause, reason or even the effect of the consolidation; that by reason of these forms, directors may do indirectly what they cannot do directly; that the addition to the capital assets of $550 works such a transformation that the directors of a corporation charged with a duty of preserving its assets and income for the benefit of its creditors may divide these assets and income among themselves under the guise of dividends to the exclusion of the creditors. There are a few facts in the transaction which cannot be disputed; *Page 354 some things were not transformed; they stand out as the main facts to be considered. The assets did not change; they were the same before, both in kind and in amount, as they were after consolidation; the directors did not change except by the addition of a few others who knew the facts. The only thing apparently which has changed under these allegations has been a corporate charter, and the alleged shifting of the duties and responsibilities of the directors.
I know of no forms of law, statutory or otherwise, which may not be used for the accomplishment of a fraud or for the illegal purposes of wrongly obtaining money, if people so desire to use them, and I know of no form of law or statute which will prevent a court of equity from seeking out the fraud, looking beyond the forms to the actual facts and compelling restitution. Compliance with forms of law does not amount to absolution for fraud. All of these corporation statutes have their legitimate purposes, but they cannot be used as a blind to pay dividends when there are no actual profits out of which to pay them.
What I have said here, of course must not be misunderstood. We are dealing merely with the allegations of the complaint and for the purpose of argument and discussion, assume them to be true in order to answer the defenses made to them. It must never be assumed by anybody who reads this opinion that we have said that such are the facts or that the allegations are true, or that our words even carry such an intimation. We are dealing merely with pleadings, and pleadings are not proof. We are passing upon allegations which, if sufficient to make out a cause of action, still remain to be established by competent proof.
The complaint further alleges the reasons why this action is brought by the plaintiff as a bondholder. The trust mortgage which was security for these bonds was foreclosed by the trustee, resulting in a large deficiency. *Page 355 The plaintiff received his proportionate part of the amount realized, but he and the other bondholders have not been paid in full. The Interborough Consolidated Corporation on or about March 28, 1919, was adjudicated a bankrupt and the plaintiff and the other bondholders received their proportionate part of the bankrupt's estate. All the estate of the bankrupt has been disposed of by the trustee. The liability of these directors of the Interborough-Metropolitan Company for their fraud would not constitute an asset of the Interborough Consolidated Corporation, at least it would not prevent the bondholders from pursuing the directors for their misfeasance as directors of the Metropolitan company.
We, therefore, think that the allegations of the complaint set forth a cause of action, and we now proceed to answer the certified questions. We agree with the disposition made by the Appellate Division of all of the defenses with the exception of one; the first question certified which relates to the second defense contained in the answer of the defendant Sullivan and others. In the answer this is designated as the first affirmative defense, but there seems to be no dispute among counsel or in the briefs that this first question relates to this so-called "no recourse defense." The answer sets forth that the bonds described in the complaint and held by the plaintiff were a part of a series of bonds issued by the Interborough-Metropolitan Company to the aggregate amount of $67,825,000, and secured by a certain collateral trust indenture under which there were pledged and placed in the possession of the trusteed securities, the value of which was largely in excess of the aggregate par amount of the bonds. The bonds, by appropriate words, referred to the trust agreement, which trust agreement contained this clause:
"No recourse under or upon any obligation, covenant or agreement of this indenture, or of any purchase money bond or coupon, or because of the creation of any indebtedness *Page 356 hereby secured, shall be had against any incorporator, stockholder, officer or director of the Company or any successor corporation, either directly or through the Company, by the enforcement of any assessment or by any legal or equitable proceeding by virtue of any statute or otherwise. This indenture and the purchase money bonds are solely corporate obligations, and no personal liability whatever shall attach to or be incurred by the incorporators, stockholders, officers or directors of the Company, or any successor corporation, or any of them, because of the incurring of the indebtedness hereby authorized, or under or by reason of any of the obligations, covenants or agreements contained in this indenture, or in any of the purchase money bonds or coupons, and any and all personal liability either at common law or in equity, or by statute or constitution, of every such stockholder, officer or director, is released and waived as a condition of and as part of the consideration for the execution of this indenture and the issue of the purchase money bonds."
The defendant further alleged in this defense that the consolidation with the Financing and Holding Company on June 1, 1915, was made in strict conformity with the statute, and that the defendants acted in good faith and without fraud in respect to said consolidation; that if there was any mistake, it was a mistake of law upon the part of these defendants.
The Appellate Division were of the opinion that this set forth a good defense. We take a contrary view. Without attempting to state the meaning and extent of this "no recourse clause," we are confident of one thing, that it did not and could not cover the future fraudulent acts of the directors. The complaint as we have indicated alleges a consolidation conceived and executed in fraud, and for the willful and intentional purpose of procuring the assets and income of the corporations. The consolidation was long after the making of the trust agreement. *Page 357 The directors could not willfully and fraudulently destroy or convert the property held as security for these bonds, whether it was pledged to the trustee or was the general assets of the corporation, and then plead that they were protected by an agreement that they should not be liable for their acts. The agreement did not relate to such future acts.
Neither does the statement in the defense that the defendants acted in good faith add anything to their denial. The plaintiff must prove bad faith, amounting to fraud, intentional acts done for the purpose alleged in the complaint, as heretofore stated. The defendants by the general denial have met these allegations and can prove their good faith or lack of knowledge or absence of any other element which the plaintiff must prove to establish fraud. We, therefore, think that this answer is insufficient and should have been stricken out.
The orders of the Appellate Division and of the Special Term as thus modified should be affirmed, with costs to the plaintiff in all courts, and the questions certified answered in the negative.