Misnomer in ‘liquidating dividends’ term
It is common practice by many lawyers and accountants to describe the assets of a stock corporation that are distributed to its stockholders when its corporate life is terminated as liquidating dividends.
The description proceeds from the idea that when a corporation has decided to wind up its operation, its properties have to be “liquidated” (whether in cash or in kind) so they can be proportionally distributed to the stockholders.
Regardless of the value of the remaining properties, parceling them out to the stockholders is generally considered a return on their investment, which is consistent with the purpose for which stock corporations are organized.
The Supreme Court had occasion recently to clarify, by way of a side comment, the proper use of the term “liquidating dividends” in the case of “Forest Hills Golf and Country Club vs. Securities and Exchange Commission.”
In a nutshell, the case is about the amendment of the articles of incorporation of the company, which is registered in the Securities and Exchange Commission (SEC) as a “non-profit stock corporation,” with regard to the voting rights of its members and the distribution of assets in case of dissolution.
Among other reasons, the SEC disapproved the amendment and ordered it to indicate in its articles that it is a stock corporation on account of a provision in its articles that states that its assets shall be distributed to its members in case of its dissolution.
The company appealed the SEC’s decision to the Court of Appeals, which the latter affirmed, and the case was elevated to the high court for final resolution.
The issue of distribution of assets after dissolution was contentious. The SEC considered it as a distribution of dividends, an act that applies to common shares in stock corporations and not to nonstock or nonprofit corporations.
Relevant to this issue is a provision in the Revised Corporation Code on nonstock corporations, which states that their articles of incorporation or bylaws shall “determine the distributive rights of members, or any class or classes of members, or provide for distribution.”
Note that when assets are distributed upon the dissolution of a corporation, they are, in practice, often described (or booked) as liquidating dividends. It’s a term that has been used for ages in legal and business circles in describing that particular transaction.
However, the court said the term “liquidating dividends” is a misnomer. It explained “that a distribution in liquidation of the corporation’s assets, which is a return to the stockholders of the value of their stock upon a surrender of their interest in the corporation, is distinguishable from a dividend paid by a going corporation out of corporate profits when declared by the directors in their discretion, which is in the nature of a recurrent return upon the stock.
“In contrast, a distribution of assets upon the corporation’s dissolution necessarily terminates or wipes out the stockholdings of the stockholders who lose all their interest in the dissolved corporation.
“Dividends represent profits realized by the stockholders from their shares, but in dissolution, the stockholders may either realize a gain or suffer a loss, depending on the assets that they receive in relation to the value of their shares.”
Take note, lawyers and accountants. In light of this pronouncement, the term “liquidating dividends” should be consigned to oblivion in commercial documents.
Any possible replacement for that term that would accurately reflect its character would probably be best left to the linguistic skills of people in the accounting profession, than to lawyers, because legalese can sometimes be confusing.
Incidentally, the court did not issue a final ruling on the case. It remanded it to the SEC to determine whether the proposed amendments are lawful in consideration of its classification as a nonstock corporation and to approve it accordingly.
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