AUSTIN m. TEXAS
WILL BVJJSION
AX-TORNKY GSNFXZAL
January 13, 1960
Honorable William A. Harrison Opinion No. WW-778
Commissioner of Insurance
State Board of Insurance Re: Whether dividends may be
International Life Building paid by a fire and casualty in-
Austin, Texas surance company out of the un-
realized appreciation in value
of some of the corporation’s
Dear Mr. Harrison: assets.
In your request for an opinion you have asked whether a fire
and casualty insurance company may pay dividends out of a surplus
arising from the unrealized appreciation in the market value of certain
assets of the company over their cost or book value. You have cited an
instance where dividends were so paid.
Article 2 1.3 1 of the Texas Insurance Code provides in part
as follows:
“It shall not be lawful for any insurance company
organized under the laws of this State to make any div-
idend, except from surplus profits arising from its
business. In estimating such profits, there shall be
reserved therefrom the lawful reserve on all unexpired
risks and also the amount of all unpaid losses, whether
adjusted or unadjusted, and all other debts due and
pay:ble, or to become due and payable by the company
. . .
Article 8.14, applicable generally to casualty insurance com-
panies, before its recent amendment provided as follows:
“The directors of any such company shall not
make any dividends except from the surplus profits
arising from their business. , .”
By the provisions of S.B. 180, Acts 1959, 56th Leg. R.S..
Article 8.14 was amended to read as follows:
“The directors of any such c’ompany shall not make
any dividends except in compliance with Article 2 1.3 1
of this Code.”
Thus, irrespective of which of the several laws apply, fire
and casualty companies are prohibited from paying dividends except
. -- ..
Hon. William A. Harrison, page 2 (WW-778)
from “surplus profits arising from its business.” The term “surplus
profits” implies among other things that payment of dividends may
only be made to the extent of a c,ompany’s surplus and, additionally,
that funds from which the payment was made arose from the profits
of the company’s business. Since you have stated that the payments
of dividends were made from surplus, the only question for determin-
ation is whether the payments were also from profits of the business
of such insurance company. In our opinion under the facts given the
payments of dividends were not from “profits arising from its busi-
ness* and were th,erefore unlawful.
It must be conceded initially that the Legislature in using
the term “profit” intended some meaning distinct from the term
“surplus” elsewise they would not have elected to use both terms.
Hence, we conclude that a profit is not the same thing as surplus.
The term “profit” has been defined by Webster’s New Inter-
national Dictionary in the following manner:
“The excess of returns over expenditure in
a given transaction or series of transactions; as:
a. the excess of the price received over the price
paid for goods sold (115 Wis. 261) b. the excess of
the price received over the cost of purchasing and
handling, or of producing and marketing, particular
goods (3 Fed. 566, 569) c. the advantage derived (as
in infringement of patents) from employing one
process or machine in manufacturing instead of
another.
“Excess of income over expenditure, as in a
business or any of its departments, during a given
period of time; specif.: a. the income of invested
property, not including an appreciation in market
value (15 Wall. 63, 65; 198 Pa. 216) b. usually in
pt. with reference to Lands the sum of revenue
yielded by it, or the proceeds derived from its
use or enjoyment, as in case of leased property
or land that is mined. Cf. profit prendre. . .”
These definitions all envision a realization of the benefits
accruing from the given transaction. Stated differently, these defini-
tions do not encompass a benefit or advantage that is yet to be realized.
The everyday business use of the term “profit” is compatible with these
dictionary statements. Unrealiied appreciation of assets does not enter
into a profit and loss statement, nor is it considered for income tax
purposes.
The general rule in other jurisdictions is that the unrealized
appreciation in value of assets cannot be utilized in determining the funds
available for distribution as dividends. 11 Fletcher Encyc. Corp. (1958
-.
Hon. William A. Harrison, page 3 (WW-778)
Revised) 1050 Sec. 5335.1; Berks Broadcasting Co. v. Craumer,
52 Atl.Zd 571, (Penn.Sup. Ct. ason, 8,
(C.C.A. - 4th - 1957 cert. den., 35; D.S. 949) and cases collected
55 A.L.R. 8, 76 A.L.R. 885 and 109 A.L.R. 1381. Support in Texas
to this general rule is in some measure iven by the case of Dealers
Granite Corp. v. Faubion, 18 S.W.Zd 737 7Aus.Civ.App. 1929) where,
in determining the meaning of the term net profits as applied to a cor-
poration, the Court stated:
“And the general rule seems to be that in-
crease in the value of lands held by a corporation
cannot be considered as profits, at least until such
lands are sold and the profits actually realized.”
The adoption of a rule permitting insurance companies to
declare dividends on speculative profits would leave the financial
soundness of the capital and required surplus accounts of insurance
companies to the vagaries and uncertainties of fluctuating market
values. We believe that the courts of this state when the occasion
arises will hold that “unrealized’* appreciation does not constitute
profit. As stated in Loftis v. Mason, supra, on page 433:
”
. . .in the application of sound accounting prin-
ciples, dividends may ordinarily be declared only out
of actual earnings or profits and not upon a theoret-
ical estimate of an unrealized appreciation in the
value of the assets.”
A different view is held in New York. (See Randall v. Bailey,
43 N.E.2d 43, (Ct. of Ap. 1942). It has been suggested that the New
York position is determinative of the proper interpretation of the Texas
provision because of certain similarities in the respective statutes.
It is true that the New York general corporation laws over a lon# period
of years, predating any of the Texas enactments, used the term surplus
profits * in limiting the source available for dividends and that several
of the New York cases suggest the possibility that this source may in-
clude unrealized appreciation in the value of corporate assets. But the
only clear holding in New York that unrealized appreciation is an avail-
able source of dividends is the case of Randalrv. Bailey, supra, which
was decided after the abandonment by the New York Legislature of the
surplus profits test and under statutory language leaving no room for
any other conclusion. Under these circumstances we do not believe
that the New York decisions are particularly persuasive.
Hon. William A. Harrison, page 4 (WW-778)
SUMMARY
Unrealized appreciation in the assets of a fire
and casualty insurance company do not consti-
tute “net profits arising from its business”
available for distribution as dividends.
Yours very truly,
WILL WILSON
Attorney General of Texas
By &db-&’
Fred B. Werkenthin
Assistant
FBW:lmc
APPROVED:
OPINION COMMITTEE:
W. V. Geppert, Chairman
Arthur Sandlin
Phocion Park
Tom McFarling
L. P. Lollar
REVIEWEDFORTHEATTORNEYGENERAL
BY: Leonard Passmore