175 Merritt-Chapman & Scoot Corp. v NY Trust Co. November 8, 1950, 184 F.

2d 954 TOPIC: Financing the Corporation; Debt Securities; Convertible Securities; Stock Options PONTENTE: J. Thomas Swan

AUTHOR: Keith Meridores (This presupposes you already have knowledge about Debt Securities, and what a dividend is; so please, read up) Note: Provisions in the contract of the security may give the holder the privilege to exchange his class of securities with another class. (e.g. he can exchange his 1 preferred share to 2 common shares) It may also be provided the period within which to exercise this privilege. Note: At times, instead of giving this privilege, whats given is a stock option warrant. This gives the holder the option to purchase stocks at a specified price and can be exercised at any time within a specified period. Note: dividend can either be paid out as cash (cash dividend) or paid out as additional stocks (stock dividend, scrip dividend). An example of stock dividend: company releases 40% stock dividend for common shares, now your 1 common stock is now 1.4 common stocks. Get it? This case concerns with stock dividend.

FACTS: 1. Merritt-Chapman (Merritt a.k.a. Corporation) entered into a trust deed with NY Trust and Co. (trustee) 2. Merritt issued warrants in 1928. 3. The warrants provide that the bearer is entitled to purchase full-paid and non-assessable shares of common stock of the Corporation upon surrender of the warrant and payment of the purchase price, which is $30.00. The warrants are to be surrendered with the trustee. 4. Pursuant to Merritt and NY Trusts trust deed, 40,000 shares of the Corporation are to be delivered to the trustee to insure that stock purchasable under the warrants would be available. 5. Merritt issued a resolution granting stock dividend in the amount of 40% per share to its stockholders who hold such legally issued and outstanding shares of said common stock. (The stocks deposited with NY Trust is also covered) - the dividend for the issued and outstanding shares is payable on Oct. 16, 1950 - the dividend for authorized but unissued shares is payable on Sept. 15, 1950 6. The resolution also directed that the holders of the warrants and the trustee the 60 day notice required by Article 3, sec. 10 of their trust deed. It provides during such period of sixty days, the holders of Warrants outstanding hereunder may purchase stock in accordance with such Warrants and be entitled in respect of shares so purchased to all of the rights of the other holders of similar stock of the Corporation. 7. The controversy arose when the 2 parties contends 2 different matters: - Merritt contends that a holder of a warrant must exercise his warrant (i.e. see #3) in order to have a share in the stock dividend (i.e. see #5) - NY Trust on the other hand contends that Merritt must deposit 40% of the stock that was already deposited with them. So that whoever holds a warrant and wishes to avail of the warrant will receive 1.4 shares. The stock allotted by Merritt for those who want to avail of the warrant is also covered by the stock dividend released. 8. The lower court ruled in favor of the Corporation. 9. NY Trust contends that in ruling in favor of the Corporation, it disregarded Article 3, sec. 7 of their trust deed which provides, upon the exercise of Warrants, deliver in the manner herein provided, with any shares of common stock purchased thereunder, but without additional consideration therefor, such number of shares as may be equal to such stock dividend, if the same had been declared upon the common stock so purchased. ISSUE: 1. Whether or not the 60 days provision in their trust deed is deemed as a period within which the warrant holders must exercise their rights or else it is deemed forfeited? 2. Whether or not Merritt should deposit 40% of the stock that was already deposited with NY Trust? HELD: 1. No. The language of Sec. 10 is not aptly chosen to express such a forfeiture.

2. Yes. If Merritt will not deposit the additional 40%, the stocks allotted for those who want to avail of their warrants will be diluted. RATIO: Issue 1: 1. The appellee (Merritt) must, and does, contend that the notice provision is for the purpose of giving the warrant holders notice that unless they exercise their warrants by the record date, they will forfeit those promised rights. Certainly the language of section 10 is not aptly chosen to express such a forfeiture. 2. The trust deed did not set any time limit specifying when the warrant holders must exercise their option. 3. The appellee points to section 10 as setting such a limit. By it the corporation merely promised to give the warrant holders and the trustee a sixty day notice 'in case the Corporation shall pay any stock dividend'- or take other specified action- 'to the end that, during such period of sixty days, the holders of Warrants outstanding hereunder may purchase stock in accordance with such Warrants and be entitled in respect to shares so purchased to all the rights of other holders of similar stock of the Corporation.' 4. The warrants gave the holders thereof the privilege, unlimited in time, to purchase an aggregate of 40,000 authorized but unissued shares. Issue 2: 1. If the corporation were at liberty to declare stock dividends without making provision for warrant holders, the percentage of interest in the common-stock capital of the corporate enterprise which the warrant holders would acquire, if they thereafter purchased the shares subject to warrants, could be reduced practically to the point of extinction. The relevant portion of their Trust Deed (read the underlined portion) Section 7. As long as the Warrants shall remain valid and outstanding, the Corporation will not pay any dividends on its common stock payable in stock of any class (such dividend being herein sometimes called 'stock dividend'), unless the Corporation shall deposit in trust with the Trustee stock certificates of the character above described in Section 3 of this Article III representing an amount of stock (of whatever class) of the Corporation equal to the amount of such stock dividend, if the same had been declared upon the common stock represented by the stock certificates then held in trust by the Trustee hereunder, and the Trustee shall, out of such additional stock certificates so deposited in trust with it on account of such stock dividend, upon the exercise of Warrants, deliver in the manner herein provided, with any shares of common stock purchased thereunder, but without additional consideration therefor, such number of shares as may be equal to such stock dividend, if the same had been declared upon the common stock so purchased; and as provided in Section 5 of this Article III, the Corporation will from time to time issue and deliver to the Trustee such stock scrip certificates as may be required from time to time to enable the Trustee upon the exercise of Warrants to make any and all deliveries in respect of any such stock dividend. 2. The purpose of section 7 was to supply such protection. It is a covenant by the corporation. CASE LAW/ DOCTRINE: *see authors note above* DISSENTING/CONCURRING OPINION: Clark, J.(Dissenting) Clark reasoned that the provisions for notice appearing in the warrant there involved must have been intended to limit the power of the warrant holder to assert rights with respect to the stock dividend because no other purposes for the time limitation in the notice could be conceived. Why, he wrote, "should the draftsmen have painted the lily further unless the sixty days was intended as a definite period for the taking of some action?"