Request By:
Jack D. Bunnell
Director, Division of Securities
Department of Banking and Securities
911 Leawood Drive
Frankfort, Kentucky 40601
Opinion
Opinion By: Robert F. Stephens, Attorney General; Mark F. Armstrong, Assistant Attorney General
We are in receipt of your letter in which you ask our opinion of whether a corporation formed under the laws of the Commonwealth may issue its stock in consideration of a promissory note.
Ky. Const. § 193 provides in part:
"No corporation shall issue stocks or bonds except for an equivalent in money paid or labor done, or property actually received and applied to the purposes for which such corporation was created, . . . ."
The initial question thus becomes whether a promissory note constitutes "money paid or labor done, or property actually received. " In
Clarke v. Lexington Stoveworks, 72 S.W. 286, 24 Ky. L.Rptr. 1755 (1903), Clarke subscribed to 25 shares of stock in Lexington Stoveworks ("Stoveworks"). Clarke was unable to pay the full subscription price and instead executed a promissory note which was collaterally secured by a life insurance policy. Stoveworks successfully sued to enforce the subscription agreement. Clark appealed.
On appeal, Stoveworks argued that the promissory note could not satisfy Clarke's obligation under the subscription agreement due to the provisions of Ky. St. § 568. This statute was identical to the constitutional provision quoted above. The Court rejected this argument and held:
"The note, secured as it was by the policy, was as good as a bill of exchange. It was therefore the equivalent of money, and its acceptance by appellee [Stoveworks] would have been a payment, in contemplation of the statute [Ky.St. § 568] supra."
Clarke v. Lexington Stoveworks, supra, S.W. at 288.
The majority rule is that a promissory note cannot be accepted by a corporation in consideration of the issuance of stock, see Annot., 58 ALR 708 (1929). 1 The Lexington Stoveworks case, supra, is an example of the exception to the general rule; namely, that a secured note does not violate the constitutional prohibition, see Annot., 78 ALR 2d 834, 847 (1961). 2
In
Fayette National Bank v. Meyers, 211 Ky. 185, 277 S.W. 292 (1925), Meyers, a director and corporate officer, purchased stock from the corporation with a check. The Fayette National Bank ("Bank") accepted the check for deposit from the corporation. When the Bank sought to collect the amount of the check from Meyers, he denied liability on the ground, inter alia, that the check was not to be deposited until an oil well was completed. The Court held that Ky.St. § 568 prohibited the issuance of stock under these circumstances but that Meyers was estopped to deny his liability on the check since he had accepted the stocks. This case stands for the proposition that the constitutional or statutory prohibition is for the protection of the corporation and its shareholders and not that of the maker of the note, see Annot., 78 ALR 2d 834, 860 (1961).
Accordingly, both the Lexington Stoveworks and Meyers cases, supra, recognize exceptions to the general rule that the provisions of Ky. Const. § 193 prohibit a corporation from accepting an unsecured note as consideration for the issuance of stock. In recognizing the exceptions to the rule, the cases implicitly adopt the rule. Therefore, we are of the opinion that Ky. Const. § 193 prohibits a corporation from accepting an unsecured promissory note as consideration for the issuance of stock.
Footnotes
Footnotes
1 The Annotation discusses cases construing statutory provisions; but these statutes are similar, if not identical, to the provision of Ky. Const. § 193.
2 See n. 1, supra; and Annot., 78 ALR 2d 834, 837 at n. 8.