M. L. HAYWARD November 1 1925


M. L. HAYWARD November 1 1925



" YES, it's a nice looking diamond, but-" the jeweller demurs. "But-what?" the owner demands. `It's `off color,' that's all." "Well, that spoils it for me." Diamonds, in spite of “off color" defects, may still have a certain commercial value, but an investor who buys “off color” securities may find that the money “invested” is worse than wasted; that his neatly engraved certificates are not worth a cancelled Russian postage stamp. It is obvious, then, that the investor should not disregard information that will put him on his guard; the Canadian and English courts have handed dowTn some important rulings along this line.

For instance, the securities may be “complete and regular on the face thereof,” as the lawyers say, the signatures of the proper officials may be appended, and the corporate seal “set like a sun in the margin,” but the documents are “off color,” because some of the stockholders claim that the proper preliminary proceedings were not taken before the securities were actually issued.

Then there are cases where the securities are regular enough, hut the company contends that the holder is not an actual stockholder.

Again, there may be a regular certificate and a recognized stockholder, but the stock has been transferred on a forged endorsement, or the document may be a plain forgery in itself, or issued without the knowledge or consent of the company.

Lastly, there may be some defect apart from the document itself.

In the first instance, the stockholder may point out that he holds a regular security authorized by a regular meeting of the company.

“We admit that a meeting was duly called to vote the new securities, but we claim that improper influences were used to get the motion through,” the dissenting faction of the stockholders will contend.

“I took the securities in good faith, and am not interested in your ‘family’ troubles,” the security holder retorts, and the courts have ruled in his favor.

In a British Columbia case it appeared that a company had issued debentures within the scope of its authority, but that there was fraud as far as “the indoor management of the company” was concerned.

“We’re not responsible for that,” the bona fide debenture holders contended, and Judge Morrison, of the British Columbia Supreme Court, ruled in their favor.

“If fraud appears it was committed as between rival warring factions in the directorate or inside element of the company. The debenture holder should not be visited with its consequences. All he had to do acting bona fide was to see that the company might have power to do what it purported to do. As I understand the issue, the contest was between

the two factions for ascendancy in the control of the company, in the outcome of which the debenture holder is now sought to be made the \iearious victim,” was the reasoning of the learned judge.

There are also cases where a resolution authorizing the issue of securities is duly passed, but some of the stockholders object to the sufficiency of the notice calling the meeting, and in an English case along this line, the Chancery Court upheld what had been done, on _ the ground that the notice “substantially put the shareholders in the position to know what they were voting about.”

This rule must not be taken too broadly, however. In a Canadian case which went on appeal to the Privy Council, that court ruled against securities issued under resolutions passed at a meeting where the notice of the meeting did not sufficiently inform the shareholders of the purpose of the meeting, so that each shareholder could judge for himself as to the propriety of issuing the proposed securities.

Then there is the second case where a company denies the standing of the security holder, and the latter sues the company for “recognition.”

In another Canadian case, a shareholder brought an action against a Canadian insurance company to establish his position as a shareholder.

“What did you give for your stock?” the company demanded. The stockholder proved no consideration for the issue of the certificate other than a personal arrangement between himself and the manager, and the court ruled against him, whereupon the shareholder appealed and claimed on the appeal that the company was precluded by its conduct from denying that he was a shareholder.

“The shareholder would be in the position of a man who admits that he has received what purports to be a certificate from an officer of the company for fully paid-up shares issued to him, for which he knows that he has given no consideration to the company, and which falsely states that the full amount has been paid up on them. As soon as the pretended contract under which he received the certificate is disproved, he can not take any advantage from the possession of the certificate, but must hand it back to the company,” said the Privy Council.

As far as the forged transfer is concerned, there are. fortunately, no Canadian cases on the point, but in an English case it appeared that a shareholder gave his address as at the office of a certain banking company, and deposited his certificate with the manager of the bank for safe keeping.

“That's easy.” the manager assured himself, sold the stock, and forged the shareholder’s name to the transfer. The company wrote the stockholder, notifying him that the transfer had been made; Continued from page 6 the notice came into the hands of the manager, who forged a satisfactory reply in the name of the shareholder, and the company registered the transfer. When the shareholder discovered this fraud he sued the company for a cancellation of the transfer, a new certificate, and the back dividends, and the English Chancery Court ruled in his favor, on the ground that leaving the certificate with the bank was not sufficient negligence to bind the shareholder, as he had no reason for assuming that the manager would make a criminal of himself for the price of the stock.

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The forged or unauthorized security problem came up in a decision of the New Brunswick Supreme Court, where the evidence showed that a bearer debenture of the Board of School Trustees of the City of St. John, was placed in circulation without the authority or knowledge of the board, and without the board receiving any value therefor. The bond was pledged with a bank, the loan was unpaid, and the bank sold the bond to a broker, who bought it in good faith and at a premium. When the first interest coupon fell due it was duly paid by the trustees. Then they refused to pay the subsequent coupons and the broker sued.

At the trial the jury found that the bond came into the broker’s hands as an innocent holder for value through the carelessness and neglect of the officers of the trustees, who were guilty of such negligence that it would be unjust to permit them to claim that the bond had not been duly issued. This verdict was upheld by the New Brunswick Supreme Court on appeal.

“The bond was properly filled in and certainly executed by the chairman under the corporate seal. It was left lying about the office; was given to the chairman, for the purpose of being negotiated, and then returned by him nobody knows when or how, and finally got into circulation with no cash for it coming to the trustees. If this is not evidence of gross carelessness on the part of the trustees, or their officers, it would be hard to find such evidence unless their action amounted to fraud,” was the reasoning of the court.

Lastly, there is the outside flaw, where, for instance, corporate bonds are issued, secured by the usual trust mortgage to a trust company and covering the corporate assets in a certain Province. Now, it is a familiar fact that practically all the provinces require outside corporations to register in the province and to pay a certain tax as a condition to doing business therein, and a corporation may issue bonds secured by the usual trust mortgage. The trust mortgage is duly recorded, an investor buys some of the bonds in good faith, and then ascertains that the trust company is not registered to do business in the province.

This point arose in a New Brunswick case, where a New Brunswick company gave a trust mortgage to secure bonds to a Massachusetts trust company which was not registered under the New Brunswick law, and then the unsecured creditors set up the claim that the bonds were invalid.

Obviously, these instances touch merely the fringe of an interesting subject, but they will tend to show that the courts, as a general rule and as far as possible, will protect the “bona fide holder for value,” in those cases where the securities involved are “off color.”