In re HAAS CO. TAYLOR v. ZIEGENHAGEN, 131 F. 232

GROSSCUP, Circuit Judge, after the foregoing statement of facts, delivered the opinion of the court: The sole question raised by this record is this: Is it within the lawful power of shareholders of a corporation, to the exclusion of creditors of the corporation, subsequent in point of time to the transaction, to use the notes, and pledge the assets of the corporation, toward paying the shareholders’ individual debts contracted in the purchase from others of such shares? We think not.

The corporation, as a statutory person, with power to transact business, invite credit, incur obligations, and to discharge them, is an entity entirely distinct from its individual shareholders, and from their power to transact business, invite credit, incur obligations, and to discharge the same.

The shareholders may, it is true, out of the assets of the corporation, declare and pay dividends; or, the affairs of the corporation being wound up, divide among themselves its capital and assets; but dividends mean the division not of capital and assets as such, but of earnings; and a final division of capital and assets means that the corporation will invite no further credit.

Under the name of dividends there can be no lawful division of assets and capital that would impair the rights of creditors; and so long as the corporation is a going concern, there can be no lawful division of capital and assets that would diminish the security upon which continuing or future credit will be presumably based. The notes and mortgage under consideration here are in no sense a dividend; they do not pretend to be a division of earnings. Nor are they a final distribution of capital and assets; the corporation remained a going concern, and invited the subsequent credit which the trustee now represents.

Unless shareholders may invade, at will, the capital and assets of the corporation, appropriating them with impunity to the payment of their individual debts, the transaction complained of by the trustee cannot be sustained. But it is said that the creditors represented by the trustee in this case had knowledge of the existence of the mortgage, and must therefore have extended their credit with notice of the facts. The contention clearly embodies a non sequitur.

Knowledge of the presence on the records of the mortgage does not imply notice that out of the capital or assets of the corporation the shareholders were paying their individual debts. The mortgage on file, so far as the creditors knew, may have been executed for corporate purposes, its avails remaining somewhere among the corporate assets. The order of the District Court is reversed, and the case remanded with instructions to enter an order denying the petition of appellee, and to subject the proceeds of the sale, first to the payment of the corporation’s just debts.