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District Court of Appeal, Second District, Division 2, California.


Civ. 10611.

Decided: November 14, 1935

Horton & Horton, Joseph K. Horton and Holbrook, Taylor, Tarr & Horton, all of Los Angeles, for appellant. Louis Ferrari, of San Francisco, and Edmund Nelson, Freston & Files, Ralph E. Lewis, O'Melveny, Tuller & Myers, and Louis W. Myers, all of Los Angeles, for respondent.

This is an appeal from a judgment in favor of the defendants after an order sustaining a general demurrer without leave to amend. In so far as the first count of the complaint is concerned, the allegations are similar to those set forth in the case of Fox-Woodson Lumber Co. v. Bank of America (Cal.App.) 51 P.(2d) 1149, the opinion in which was filed by this court yesterday. We refer to that opinion for a full statement of the facts in this case. Our decision as to the first count is the same and our reasons for the decision are stated in the opinion in that case.

The original complaint in this case was filed in the year 1931. Thereafter and on October 11, 1934, the decision of the Supreme Court in the case of Young v. Three for One Oil Royalties, 1 Cal.(2d) 639, 36 P.(2d) 1065, was rendered. Thereafter and on May 13, 1935, the plaintiff filed an amended complaint containing a second count in which it was alleged that the so-called participation certificates, i. e., the certificates issued for the construction of the Arcady Apartment Hotel, were void as having been issued in contravention of section 11 of article 12 of the Constitution of this state and of section 359 of the Civil Code as these laws existed in 1927 and 1928, which provide in effect that the bonded indebtedness of a corporation shall not be increased without the consent of the persons holding at least two-thirds of the amount in value of the stock. The second count alleges that no such consent was obtained and that no meeting of the stockholders was held as required by said section 359. Defendants, on the other hand, contend the certificates do not constitute “bonded indebtedness” within the purview of the Constitution, and that even if the certificates did represent bonded indebtedness they would not be either void or voidable.

The law is meager in California as to what constitutes “bonded indebtedness.” In an otherwise splendid opening brief plaintiff takes it for granted, largely, that the certificates before us constitute bonded indebtedness and contents itself with the following assertion in that behalf: “The rules of law, as to what constitutes a bonded indebtedness of a corporation, are so generally known and settled that we feel justified in referring to, as authority in this respect, 14a C.J., Corporations, p. 610, § 2563.” Turning to this authority, which as we have said is the only one cited by plaintiff in support of this contention, we find it reads as follows: “In the ordinary meaning of the term, a corporate bond is a written promise by a corporation under seal to pay a fixed sum of money at some future time named, with stated interest payable at some fixed time or intervals, given in return for money, or its equivalent, received by the corporation, sometimes secured, and sometimes not.” It is obvious that this is a very general definition, so broad in its terms as to include ordinary promissory notes and a wide variety of other contracts which plainly and unmistakably are not corporate bonds. It must be remembered that the question which now confronts us is not whether the certificates constitute a “security” under the Corporate Securities Act (St. 1917, p. 673, as amended), but whether they constitute a “bonded indebtedness” within the meaning of the Constitution and Code provisions.

In the case of Underhill v. Santa Barbara, etc., Co., 93 Cal. 300, 28 P. 1049, 1050, the contention was made that certain notes issued by a corporation and secured by mortgages in consideration of labor and material furnished to the corporation constituted a bonded indebtedness within the meaning of said constitutional provision. The court said: “If the constitution does not prohibit a corporation from securing every kind of indebtedness by mortgage, it follows that the mere fact that a corporation debt is secured by mortgage does not show that it is of the kind prohibited, and that the prohibited kind must be distinguished by some other attribute than that of mortgaged security. It will hardly be contended that section 11 of article 12 of the constitution was intended to prohibit all increase of indebtedness not authorized by a general law and consent of a majority of the stockholders; much less, that it was intended to prohibit mortgage security for any kind of indebtedness which a corporation may lawfully incur. Conceding that, to constitute ‘bonded indebtedness,’ in the constitutional sense, it must be secured by mortgage, it does not follow, as contended by counsel, that all indebtedness secured by mortgage is ‘bonded indebtedness' in that sense.”

In the case of Bank of Newman v. Monterey County, etc., Co., 48 Cal.App. 263, 191 P. 970, the defendant corporation had placed a written guaranty upon the bonds of another corporation and the contention was made that this guaranty constituted a bonded indebtedness. The court said: “We are unable to agree with the position taken by the appellant in this regard. The guaranty in question appears upon its face to have been issued for value received, and there is nothing in this record to indicate that it was not issued in good faith and in the regular course of the business of the corporation issuing the same. It does not purport to have any relation to any past bonded indebtedness of the appellant, or to have been issued in the form or with the intent of creating or increasing any bonded indebtedness of the corporation; but, on the other hand, it appears as to both its form and substance to belong to that class of written instruments which include promissory notes, checks, bills of exchange, and like obligations of corporations or of individuals issued in the ordinary course of business. The term ‘bonded indebtedness' has never been held to apply to or include this class of obligations, but as used in the Constitution and statutes has had reference to those more formal transactions of both municipal and private corporations which require such prerequisites as elections, or the express approval of stockholders, in order to their creation, and which when thus permitted take the express form of bonds.” (Italics ours.)

While it would be difficult and perhaps unwise to attempt to accurately define the term “bonded indebtedness,” it is apparent that some regard must be had to the questions: Was the paper which is in controversy formally issued as a bond? And, was it of such nature as to be recognized and accepted as such by the business and financial world?

The so-called “beneficial certificates” which we have under consideration were issued in the first instance only to contractors, subcontractors, and materialmen who had furnished labor and material to Arcady in its regular course of business and had agreed with Arcady to accept a portion of their compensation in the form of an undivided interest in a $600,000 note and trust deed. When such contractor or materialman performed his services or furnished the material agreed upon he became entitled to an undivided interest in that promissory note and trust deed. His certificate when issued merely provided him a convenient evidence of his ownership of such an undivided interest. This case was submitted in part upon the briefs which were filed in the Fox-Woodson Lumber Company Case and this court has had the benefit of all the briefs in this group of cases. The so-called beneficial certificates were never referred to in any of them, so far as we recall, as constituting a bonded indebtedness. They were not designated as such even by the plaintiff herein until four years after the commencement of the action. It is admitted in the briefs that defendant throughout the entire transaction acted in the utmost good faith and without profit to itself other than the usual fee for acting as trustee or registrar, and to hold at this late date that these participation certificates constitute the creation of a bonded indebtedness would be to impose in effect a penalty or forfeiture upon the defendant. Our conclusion is that the certificates do not constitute the creation of a bonded indebtedness within the meaning of the constitutional provision. Holding as we do, it is unnecessary for us to consider the other contentions of the parties.

Judgment affirmed.

CRAIL, Presiding Justice.

We concur: WOOD, J.; McCOMB, Justice pro tem.

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