Rhode vs Dock-Hop Company et al.

[1920]

SUMMARY: Action by the judgment creditor of a corporation against certain stockholders, seeking to
collect unpaid balances on the par value of their shares. The stockholders paid only 25 cents on the dollar
for the par value of the stocks. Their defense was that they were not subscribers. Court held that the
stockholders were not liable. The transferee of “watered stock” who takes it in ignorance of its real
character is not required, even at the suit of a creditor of the company, to pay in anything more upon it.

FACTS:

 A creditor of the Dock-Hop Company filed a complaint against defendants, alleging they were
subscribers and stockholders of the corporation and that only 25 cents on the dollar had been
paid in on the par value of their shares.
 Defendants denied that they were either subscribers or stockholders, or that the full par value of
their stock had not been paid.

ISSUE: W/N defendants are liable for the deficiency – NO

W/N there is deficiency – YES

Court found, by ample evidence, that only 5/12 of the par value had been paid.

W/N defendants were stockholders – YES

It was admitted at the trial that defendants were stockholders almost from the inception of the company.

It made no difference whether they were subscribers or not; that they were shareholders and the shares
were issued for property which the directors did not believe was equal to the shares’ par value were
enough to warrant judgment against them.

Where a person accepts ownership of stock which purports to be fully paid, the principle is that one giving
credit to a corporation is entitled to rely upon its ostensible capitalization as the basis for the credit given.
When the corporation issues “watered stock” and assumes ostensible capitalization in excess of its real
assets, the transaction misleads subsequent creditors and constitutes constructive fraud.

The essence of the right of the creditor to contest the issuance of the stock as fully paid and compel
payment of the balance is that its issuance “as fully paid” was a fraud.

W/N defendants are liable – NO

The transferee of watered stock who takes it in ignorance of its real character is not required, even at the
suit of a creditor of the company, to pay in anything more upon it. Any other rule would subject an
innocent purchaser of corporate stock to obligations in large amounts which he did not know of when he
bought the stock.

Judgment reversed; defendants were innocent transferees of watered stock.

* watered stock – shares of a company issued at a much greater value; artificially inflated prices