## Facts

- L.L. Constantin & Co. (Constantin), a New Jersey corporation, amended its certificate of incorporation to create preferred stock providing: “The holders of the preferred stock shall be entitled to receive, and the Company shall be bound to pay thereon, but only out of the net profits of the Company, a fixed yearly dividend of Fifty Cents (50¢) per share, payable semi-annually.”
- The preferred stock certificates contained substantially the same dividend provision.
- Arizona Western Insurance Company (Arizona) held 10,000 shares of Constantin’s preferred stock as record owner from on or about October 1, 1954, to on or about February 1, 1956.
- On December 28, 1954, Constantin’s board adopted a resolution declaring a dividend on preferred stock payable January 15, 1955, to stockholders of record on December 30, 1954.
- Arizona qualified for the declared dividend on its 10,000 shares (10,000 × $0.50 = $5,000), but Constantin did not pay Arizona that dividend (although dividends were paid on certain other preferred shares).
- For 1955, Constantin declared no dividend and paid no dividend to any preferred stockholder, while Arizona alleged that Constantin had net profits sufficient to pay the fixed preferred dividend required by the charter and certificates.
- Arizona sued Constantin in federal district court (diversity jurisdiction) seeking recovery of dividends it claimed were owed on the preferred stock, including the unpaid declared dividend and the fixed yearly dividend for 1955.
- S & C Trading Co., Inc. intervened, asserting rights to dividends as a transferee of Arizona’s shares.
- On summary-judgment proceedings, the district court ruled against Arizona on the claim that Constantin was required to pay the 1955 dividend absent a further board declaration. Arizona appealed.

## Issues

1. Whether the charter and stock-certificate provision stating the company “shall be bound to pay” a fixed yearly preferred dividend “but only out of the net profits” created a contractual duty to pay the 1955 dividend when net profits existed, even though the directors did not declare a dividend for 1955.
2. Whether New Jersey corporate law permits a corporation, through its certificate of incorporation and preferred-stock terms, to limit directors’ usual discretion over dividends by making payment mandatory upon the existence of net profits.

## Decision

- The Third Circuit reversed the district court’s ruling that Constantin had no obligation to pay a 1955 preferred dividend without a declaration, and remanded for further proceedings consistent with its opinion.
- The court held that the certificate of incorporation amendment and the preferred stock certificates constituted a contract between the corporation and the preferred shareholders as to dividend rights.
- The court interpreted the language “shall be entitled to receive, and the Company shall be bound to pay” as imposing a mandatory obligation to pay the fixed dividend when net profits were available for that purpose.
- The court concluded that New Jersey law did not bar such a provision; a corporation may validly issue preferred stock with dividend rights that require payment out of net profits and that restrict directors’ freedom to withhold dividends once the stated condition is met.
- Based on the record (including admissions bearing on profitability), the court treated the “net profits” condition as satisfied for 1955 for purposes of rejecting the defense that payment remained purely discretionary, leaving remaining matters (including any disputes involving the intervenor’s claimed entitlement) for the district court on remand.

## Legal Principles

- A corporation’s certificate of incorporation and the terms printed on stock certificates can form an enforceable contract defining the rights of preferred shareholders, including dividend rights.
- Clear language that preferred holders “shall be entitled to receive” a fixed dividend and that the company “shall be bound to pay” it, conditioned only on the existence of net profits, creates an enforceable duty rather than a mere authorization for directors to declare dividends.
- Although directors ordinarily control dividend declarations, that general rule yields where the corporation has lawfully agreed, in its charter and stock terms, to pay a fixed preferred dividend from net profits once the specified financial condition exists.
- Under New Jersey law, preferred-stock terms may validly define dividend rights and may restrict director discretion, so long as the dividend obligation is tied to a lawful source of payment such as net profits.

## Conclusion

Arizona Western Insurance Company v. L.L. Constantin & Co. holds that, under New Jersey law, a preferred-stock provision stating the company is “bound to pay” a fixed dividend “only out of net profits” is a contractual commitment: when net profits exist, directors may not avoid payment by simply declining to declare a dividend, and the case was remanded for proceedings consistent with that enforceable obligation.


Arizona Western Insurance Company v. L.L. Constantin & Co., 247 F.2d 388 (1957)