5. Paying for stock with property.—When stock is paid for with property other than cash, the directors may place their own valuation upon the property. If they are bargaining with an outsider, they will of course give as little stock for the property as the owner is willing to accept. If they or their friends control the property, however, and it is desired to water the stock of the company, that is, to issue it without the corporation receiving full money's worth at par, they may do so by assigning an exorbitant • value to the property which is exchanged for the stock. The stock will then be issued as full paid, in conform ity with law, and may be sold or given away at their pleasure, either by the promoters personally or as treasury stock of the company. This overvaluation of property in exchange for stock effectively nullifies the legal theory that stock cannot be issued unless paid for at par.
Two well-known cases will serve to illustrate the point. When the United States Steel Company was formed in 1901, it entered into a contract with a syn dicate, headed by Mr. Morgan, in which it agreed to turn over its securities in exchange for the securities of the ten large steel companies that were to compose the combine and $25,000,000 in cash. Under this agreement, the Steel Company delivered practically its whole authorized capital stock to the par value of $550,000,000 common, $550,000,000 preferred, and also $304,000,000 in bonds, in exchange for $25,000 000 in cash and the securities of ten steel companies. The par value of the United States Steel securities was perhaps double the actual value of the securities taken in exchange. The common stock represented a capitalization of the anticipated economies of com bination; in the expectation, since realized, that in creased earnings would enable dividends to be paid on a larger capitalization than had been possible under ten separate and competing companies. Here, then, is an instance in which property, consisting of the securities of other companies, was over-valued in order that full-paid and non-assessable stock of the new company might be issued.
The United States Leather Company, formed in 1893, represents a typical voluntary combination. Without much assistance from outside promoters and by agreement between the companies interested, com mittees were appointed to appraise the holdings of the various concerns. The consolidated company then paid $100 in common and $100 in preferred, par value, for the assets acquired, based upon the ap praisals of these committees. In other words, the company paid for the tannery and bark properties with its preferred stock, giving an equal amount of common stock as a bonus. The capitalization thus
overvalued its assets two to one.
6. Effect of issuing stock for overvalued property. —If the company has not received money's worth at par for its stock, the creditors, in the event of the com pany's becoming insolvent, may usually recover from stockholders, by proving the fact that the stock was issued for overvalued property or services, making allowance in favor of stockholders, of course, for rea sonable differences of opinion as to the value of the property or services received. Only the state, or cred itors of the insolvent company, may question the trans action, and the lapse of considerable time does not re move their remedy. In many instances courts have assessed, for the benefit of creditors, shares marked "full-paid and non-assessable." Such cases, however, usually arise in companies of small or moderate size in connection with the attempt of promoters to de fraud subscribers or creditors for the purpose of se curing excessive profits.
7. Liabilities of directors and rights of subscribers in overvaluation.—In many states, directors who knowingly issue stock for overvalued property or services may be held accountable to the creditors of the company, if it afterwards becomes insolvent and, in a few states, they may be imprisoned. The mod ern tendency is to hold directors and officers of cor porations personally responsible for all the wrongful acts and omissions of the company. Fining a cor poration only results in reducing its profits, thus im posing the punishment upon innocent stockholders. But to imprison or fine officers and directors places the responsibility and punishment for intentional vio lation of the law where it belongs.
When a subscriber who has really paid for his stock at par, finds that other subscribers have been permit ted to pay less, he is entitled to have his subscription canceled and his money returned, on the grounds of fraud. But if the subscriber has taken stock, and a new stock issue is afterwards sold for overvalued serv ices or property, he has no relief except to prevent by litigation or otherwise the issuance of the new shares. Subsequent issues of stock are frequently put out at a discount, with the consent of stockhold ers, in order to get much needed additional capital. The innocent holder, who subsequently purchases such stock without knowledge of the circumstances attend ing its payment, cannot usually be held liable to cred itors, since he is entitled to the assumption that the stock which he is purchasing has been legally issued in the first place.