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If an adequate corporate surplus is available for the purpose, directors may not withhold the declaration of dividends in bad faith. But the mere existence of an adequate corporate surplus is not sufficient to invoke court action to compel such a dividend. There must also be bad faith on the part of the directors.
From 1931 until 1945, no dividends had been paid upon the common stock of Gottfried Banking Corporation, a closely held family corporation. An analysis of the financial statements of the corporation showed a net working capital deficit at the end of 1941, in which year a consolidated loss of $109,816 had been incurred. Moreover, until the end of 1943, the earned surplus was relatively small in relation to the volume of business done and the growing requirements of the business. In the early part of 1945, the plaintiff minority stockholders of the corporation brought the present action to compel the Board of Directors to declare dividends on its common stock. The action was predicated upon the claim that the policy of the Board of Directors with respect to the declaration of dividends is animated by considerations other than the best welfare of the corporations or their stockholders.
Did the circumstances warrant the grant of plaintiffs’ motion to compel the Board of Directors to declare dividends on the corporation’s common stock?
The court held that the corporation's surplus was not so large as to demand the conclusion that the failure to declare dividends was motivated by other than sound business strategy, particularly in light of special circumstances, including the uncertainty of earning capacity during war years and heavy expenditures required to finance the company's growth. The court noted that while there was evidence of strong hostility between the minority and majority stockholders, including the removal of two stockholders from the corporate payroll, that alone did not indicate a bad faith effort by defendants to force the stockholders' sale of their interest in the corporation. The court also held that salaries and bonuses paid to majority stockholders were reasonable in light of their extraordinary service to the corporation, primarily in expanding the corporation. The court noted that while the stockholders disagreed with this plan of expansion, there was no evidence that the plan was improper; the majority stockholders would suffer equally if their business plan failed.