John Berryman, Plaintiff, v. Bankers' Life Insurance Company, Defendant

John Berryman, Plaintiff, v. Bankers’ Life Insurance Company, Defendant. First Department, February 15, 1907. insurance — dividends may be. paid from, surplus only — when policyholder cannot recover dividend illegally declared — when company cannot recover former dividends paid. An insurance company can only pay dividends out,of surplus and profits; they cannot, lawfully be paid out of capital contributed by shareholders for the purpose of carrying on the company’s business and for the protection of its creditors. Such dividends "are prohibited by section 594 of the Penal Code and section 83 of the Insurance Law. / s - Although illegal dividends, which depleted the capital, have been declared, -a policyholder who has not yet drawn his dividend cannot compel the payment thereof, when the payment would necessarily he made out, of the capital and not out of the surplus, as the officers'of the corporation would be required'to do an illegal act. ' But when former dividends paid to the insured aré not shown to have impaired the capital, they cannot be recovered by the insurer or declared to be a lien • upon the policy on the ground that they were not formally declared,by the hoard of directors or by the executive committee, if neither timecharter nor the by-laws specifically provided by whom the dividend should he declared. " When such company has paid dividends to a policyholder who stands in the position of a-creditor without notice of any infirmity in the manner in which the dividend was' declared, the payment must he considered to have been voluntary and cannot be recovered. Even though the payment were unauthorized, the acquiescence of'the company therein is a ratification; and the payment cannot he charged as an offset against the policy. ' Submission of a controversy upon ah agreed statement of facts pursuant to section 1279 of tlié Code of Civil Procedure/ The Bankers’ Life Insurance Company of the City of New York is a corporation originally organized as a fraternal, organization on March 24, 1869,-under the name of the “Bank Clerks’ Mutual Benefit Association of the City of 'New York.” ■ On the 15th day of August, 1884, it was formally incorporated under chapter 175.of the Laws of 1883, under, the same, name, .and was thereafter; on June 28, 1893, reincorporated under-article'6 of chapter 690 of the Laws of 1892, known as the “ Insurance . Law,” for the purpose óf doing business on the regular assessment, or co-operative plan, under the same name. By an order of the Supreme Court of the State of Hew York, made April 27,1894, its name was changed to the Bankers’ Life Insurance Company of the City of Hew York. Pursuant to the provisions of chapter 693 of the Laws of 1893, entitled “ An act authorizing all insurance companies transacting business on the, co-operative or assessment plan to re-incorporate as a stock corporation under its existing corporate name/’’ it reincorporated as a stock corporation on the 2d day of August, 1899, with a capital stock of .$100,Q00, and has ever since been doing business as a stock company. As a stock company the Bankers’ Life Insurance "Company was reasonably successful at the start, and it gradually increased its surplus so that on the 1st day of January, 1902, it had, as appears by its report, a surplus, beyond its capital of $100,000, of $185,576. In the fall of 1902 the stock control of this company, which was then lodged in two of its directors, William C. Demarest add Charles 'H. Fancher, was transferred to a corporation known as the Knickerbocker Investment Company. A voting trust agreement was entered into by the officers of the Knickerbocker Investment Company without the knowledge or consent of the stockholders, by the terms of which the stock control of the Bankers’ Life Insurance Company was vested for the period of five years in three voting trustees, Foster M. Yoorhees, Edward C. Stokes and William Sherer, who promptly elected themselves and certain of their friends and relatives into office. Foster M. Yoorhees became president of the company; William Sherer, vice-president, and his son general counsel. ' Edward C. Stokes became a director and the position of third vice-president was created for his brother, Howard K. Stokes. Before assuming office the stock had always paid six per cent dividends. They ran the company at a rate of expense not commensurate with the premium income of the company. They devised different schemes to make their policies attractive. ■ Among other things they did was to declare and pay out dividends on participating policies which had never been earned, and armed with literature showing the payment of. these dividends, their agents sought to procure business by showing the attractive resulta obtained. During the year 1902 the company lost $46,562 in surplus'and the officers declared and paid $2.1,035 dividends to policyholders. During the year 1903 the company lost $75,542 in surplus and the officers declared and paid $25,827 dividends to policyholders. . During the year 1904 the company made an apparent gain of $23,253 and declared and paid dividends of $35,000 to policyholders. During the year 1905 the surplus of $86,724 and the capital of $100,000 suffered further diminution, so that the statement of December 31, 1905, showed that the entire surplus had been wiped out and the capital reduced from $100,000 to $28,403, an impairment of $71,597 in its capital, and yet during that year the com- . pany declared' to the policyholders $81,000 in dividends, of which $49,000. was paid and $32,000 not yet withdrawn. A tabulated statement showing capital and surplus from January 1, 1902, to December 31, 1905, together with losses or gain on the business aiid dividends paid policyholders is as follows : Year. Capital ($100,000) Loss or gain during, the year. Dividends paid and surplus. Loss. Gain. /-policyholders. January 1, 1902 $285,576 December 31,1902 239,013 $46,536 $21,035 December 31,1903 163,471 75,542 25,827 December 31,1904 186,724 ■ $23,253 - 35,401 December 31,1905 28,403 158,321 49,537 $280,426 $23,253 $131,800 23,253 ¡Net loss between January i, 1902,- and December 31, 1905. $257,173 Dividends declared, but not paid.....:. . ,. '......... 31,019 ■ $162,819 The capital was found to be impaired by the ¡New York Insurance Department in the spring of 1906 and the stockholders of the company were called upon to make good the impairment. All the minority stock which was controlled by the management and their friends, with the exception of five shares of stock, refused to make good any portion of the impairment, and the Knickerbocker Investment Company was.compelled to pay and did pay into the.treasury of the company the whole amount of the impairment, amounting to some $72,000. Before doing so, however, the Knickerbocker Investment Company insisted that the voting trust- agreement be abolished, and the directors and officers of the Bankers’ Life Insurance Company should resign. This was finally acquiesced in, every officer and director of the company resigned, and in their place were elected the present management of the Bankers’ Life • Insurance Company. Upon an examination made by the new management into the affairs of the company it was ascertained that the capital and surplus of $285,000, which existed in 1902, had been reduced to $28,000 in 1906. The corporation sustained a loss of $257,000 in four years. Its reports during that time show that its rate of mortality was lower than the expected rate, and that it had suffered no loss in its investments. And it was found that although losing $257,000 during these four • years they had paid over $131,000 of dividends and’ had declared and not paid out som¿ $31,000 of dividends. This latter item was considered a liability by the Department of Insurance and treated as such'in. the report of 1905. . These dividends had never been passed upon by the board of directors, but were paid by the officers. With an insignificant exception the dividends had not been passed upon by the' executive committee. Neither the charter of the company nor its by-laws provide how dividends shall be declared and paid. Prior to 1902 all dividends had always been passed upon by the board of directors. Following are all the by-laws which describe the powers of the board of directors and the respective officers! 1. The officers of the company shall consist of a president, a first, a second and-a third vice-president, a secretary, an assistant secretary and a treasurer, and two or more of said offices, except that of president, may be filled by one individual. ■ 2. The president shall be ex officio a member of all committees. "In order to expedite the business of the company he shall appoint from the board of directors a finance committee of six members and an executive committee of five members, and shall provide for said committees a clerk, who shall act as secretary and keep' a correct record of the proceedings of such committees. ' .The'president shall have the general direction and superintendence of the affairs of the company and shall render reports of same at every fated-meeting of the directors, 3. The secretary, the assistant secretary and the treasurer shall perform their duties under the direction of the president. In the absence of the. secretary his duties shall be performed by the assist tot secretary, and in the absence of the treasurer liis duties shall be performed by the secretary or the assistant secretary in the capacity of acting treasurer. - 4. The officers of the company shall have power, under the rules and regulations, for the time being, of the board of directors, to negotiate contracts for business'on life and for annuity, and all other 'contracts .necessary for the company in the management off its affairs. All such contracts shall be'signed by at least two of the executive officers of the company, the printing of facsimile signature of the president to shell contracts being a compliance with this provision! . 5. The executive committee, two members of which shall" con- ' stitute a quorum, shall assist the president in the- general manage-, ment and conduct of thé business of the company. 6. The board of directors shall have charge of all .funds of the company and' see to 'the' safe investment thereof. ..All moneys shall be deposited iir the name of the company in such bank, .trust company or depositories as shall be designated by such board,'it'being required .that .alVchecks against the funds of the company shall be signed by at least two of the executive officers of the company'. The directors may determine the rates of prerninm, the amounts to be insured on any one life, and the terms qf insurance, and shall have power to purchase, for the- benefit of the company, any policies of insurance, dividends or other obligations issued by the company* and also- any claims of policyholders for profits growing out of its business. . .. ... 'The dividends can be "roughly treated in two classes: Those that . have been declared and paid out, and those that were declared hut' have not yet- been withdrawn by the. policyholders, amounting,- as above stated on the.thirty-first day of December; to $31,000. As' to these latter amounts, it became obvious to the present officers of this company that they had absolutely no right to pay dividend which they knew had not been earned, and that such action on their part would render them liable to prosecution. ■ They knew further that the impairment of the capital' of the company,- amounting to $72,000 found on December thirty-first, was partly caused by the piayment of unearned dividends: They felt they had no right to discriminate between the dividends declared and paid and the dividends declared but not withdrawn, and the only way was to treat them all alike. Hence the resolution passed March 28, 1906. Hpon assuming office the new board of directors in April of 1906, passed the following resolutions: Whereas, an examination of the affairs of the company shows that during the following years the following dividends have been paid to policyholders, namely : During the year 1902 the sum of.............1..... $21,034 77 During the year 1903 the sum of.................. 25,827 44 During the year 1904 the sum of................. 35,401 52 During the year 1905 the sum of.................. ■ 49,537 28 and during the year 1906 to date the sum of $11,876.47. Whereas, on the 1st day of January, 1902, the capital and surplus of the company amounted to $285,576.36, and, whereas, since the 1st day of January, 1902, the business of the company has yearly shown a net loss until the 1st day of January, 1906, the above capital and'surplus of $285,576.36 was reduced to $28,403.43, and, whereas, each of the above dividends as paid or declared by the company were not paid or declared out of the profits of the company, but were paid or declared out of the reserve, ■ capital and surplus, and such declaration was, therefore, void and illegal. Resolved, that all actions of the board of directors, of -the executive committee, or of the officers of the company in declaring such dividends be rescinded, and that the' following action be taken relative to the dividends declared or to be declared, on the different policies. As to ordinary life, limited payment life and endowment policies, editions April, 1898, and-January, 1899, the dividends so paid shall be charged against such policies, the insured being notified, and shall remain a lien thereupon at five per cent per annum until paid, which payment may be made by note, cash or installments with subsequent premiums, provided, however, that where such dividends, or any part thereof, are still standing to the credit of such . policies, the. same shall be charged back, and their respective holders be notified'of same. As to all other forms of policies, all dividends paid since the 1st day of January, 1902, shall be a lien upon the policy with five per cent interest from the date of the several payments, and shall be deducted in any settlement of the policy. As to the item of $31,019.06, or any other dividends declared since the 1st day of January, 1902, and carried on the books of the company as a liability, the same not having been earned and having been improperly declared, as aforesaid, they shall be abrogated and the amount thereof shall be turned over to the profit and loss account of the company. As to all dividends that have been declared and .paid on any form of policy since-the 1st day of January, 1906, these dividends shall be a lien upon the policy together with five per cent interest from the several dates of payment, and shall be deducted in any settlement made of the policy. All interests or dividends heretofore paid, or credited, shall be charged up to date on each policy and then on December 31, 1906, and annually thereafter. The plaintiff, being of full age, is the holder of its participating twenty-payment life policy Ho. 7891 for $5,000 issued on "the 14-th day of October, 1899, calling for the payment of an annual premium or consideration of $284.50, which is in full force and effect" He received in dividends the following amounts: In 1901, the sum of........................ ........ $57 15 In 1902, the supi of........-........................ 28 50 In 1903, the sum of................................. 30 00 In 1904, the sum of.................................. 31 55 $147,20 In 1905, dividends applicable to the policy and amounting to $50.60 were declared but not paid. Plaintiff demands judgment for the sum of $50.60 together ■ with costs. Defendant demands judgment: 1. That plaintiff be deemed to be not entitled to such sum of $50.60. 2. That the defendant have judgment against plaintiff for the sum of $147.20, to be charged as a lien on his policy. George W. Garr, for the plaintiff. D. Cady Herrick, for the defendant. Sic. Laws of 1893, chap. 690.— [Rep. [MAJORITY — Scott, J. :] Scott, J. : The dividends over which this controversy has arisen may be divided into two classes, those declared and -partly paid out of capital, and those declared out of surplus, the payment of which did not, however, impair the capital. The dividend which plaintiff seeks to recover falls within the former class. Nothing is better settled than that dividends should be paid out of surplus and profits, and cannot be lawfully paid out of capital contributed by the shareholders for the purpose of carrying on the company’s business and for the protection of its creditors. (2 Thomp. Corp. § 2126; Morawetz Corp. [2d ed.] § 453.) To pay a dividend otherwise is forbidden by the Penal Code (§ 594), and the Insurance Law (§83) authorizes dividends to policyholders to be paid only out of the surplus of the company. To require the defendant to pay plaintiff the premium declared iipon his policy fov the year 1905, which, if paid, would necessarily be paid out of capital and not out of surplus, would be to compel the officers of defendant to do an illegal act. Of course, no such judgment can l)e made. As to the right of the defendant to recover from other policyholders dividends which have been paid them out of capital we cannot now pronounce any judgment as the parties to be affected are not before the court. Concerning- the dividends heretofore paid to plaintiff which it is now sought to charge against him as a liability, a different question arises. It does not appear that the payment of these dividends impaired the capital of the company. The only ground of objection to them is that they were not formally declared by the board of directors, or even by the executive" committee, Ueither the charter nor bydaws provide specifically by whom dividend's' shall be declared, and in the absence of any specific provision on the subject we suppose that the discretion of determining how much of the surplus" and profits earned by the company should be divided among, the policyholders, is a matter peculiarly for the board of directors. Perhaps, if. the company refused to pay such a dividend it might have defended a claim for the. dividend upon the ground that it had never been declared by competent authority. _ But having paid it to plaintiff, who, as a policyholder, stood in a position analogous.to that of a creditor, without notice of any infirmity in the manner of declaration, we think -that the payment must be considered as a voluntary payment by the defendant, and that it may not now be recovered. The acquiescence of the company in the unauthorized act of its officers implies ratification. If the company could not recover .back the, dividends, we know of no principle that will permit'it to charge them as .a liability against the policy to be collected .thereafter, . • There must be judgment without costs: i^rszi,,that the plaintiff is not entitled to recover from defendant the sum of fifty dollars and sixty cents, declared as a. dividend upon his policy in the year 1905, but hot paid; and, second,, that the defendant is not entitled to recover from plaintiff, to be charged as a lien upon his policy, the siim paid him in the years 1901 to 1904, both inclusive, as dividends irpon. his- said policy. Pattebsob, P. J., Ibobaham, Laugheih and Clabke, JJ., concurred. Judgment ordered as directed in. opinion, without costs. Settle' order on notice. This section has been amended by Laws of 1906, chap. 326.— [Rep.