were indispensable to the contemplated improvement, and for the large investment arising out of the then comparatively new state of the art of electric railways for a large system.1

§ 1090. Capital sunk in past operations.

On the other hand, where the constitutional question is raised whether the Legislature may without confiscation so reduce rates as to leave a return only on the value of the present property, it would seem that it cannot be said to be taking that which no longer exists-capital sunk in the enterprise. Thus in disallowing the cost of unsuccessful experiments a Federal court 2 said: "Nor should there be included any amounts expended or investments made by plaintiff in its attempt or experiment, however laudable these attempts may have been, to supply fuel gas to the citizens of Des Moines, and which were expended or invested in directions not now required, or not properly serviceable for the company's present uses. These must be laid aside, among any other unprofitable investments in the history of the company. These may evidence the creditable desire of the company to keep its works fully abreast with progressive ideas of gas making. But they are now of no market value. In other words, the court may not now regard the rates as properly to be increased above what would otherwise be reasonable for the purpose of allowing plaintiff to recoup losses heretofore incurred in any unfortunate or unprofitable investments it has made, or to charge and receive interest on losses thus incurred." 3

1See also Metropolitan Trust Co. v. Houston & T. C. R. R. Co., 90 Fed. 683 (1898).

2 Capital City Gaslight Co. v. Des Moines, 72 Fed. 829 (1896).

But see Metropolitan Trust Co. v. Houston & T. C. R. R. Co., 90 Fed. 683 (1898).

Topic B. Outstanding Capitalization

§ 1091. Nominal capitalization outstanding unconclusive. If stock is issued for no real consideration, or for more than the actual consideration received, it clearly cannot be taken as any indication of the capital. This was vigorously said by Mr. Justice Harlan in a leading case:1 "It cannot, therefore, be admitted that a railroad corporation maintaining a highway under the authority of the State may fix its rates with a view solely to its own interests, and ignore the rights of the public. The rights of the public would be ignored if rates for the transportation of persons or property on a railroad are exacted without reference to the fair value of the property used for the public or the fair value of the services rendered, but in order simply that the corporation may meet operating expenses, pay the interest on its obligations, and declare a dividend to stockholders. If a railroad corporation has bonded its property for an amount that exceeds its fair value, or if its capitalization is largely fictitious, it may not impose upon the public the burden of such increased rates as may be required for the purpose of realizing profits upon such excessive valuation or fictitious capitalization; and the apparent value of the property and franchises used by the corporation, as represented by its stocks, bonds, and obligations, is not alone to be considered when determining the rates that may be reasonably charged." 2

1 Smyth v. Ames, 169 U. S. 466, 42 L. ed. 819, 18 Sup. Ct. 418 (1898).

And see particularly the language of Mr. Justice Moody in Knoxville v. Knoxville Water Co., 212 U. S. 1, 53 L. ed. 371, 29 Sup. Ct. 148 (1909).

2 Outstanding capitalization was

said to be inconclusive in the following cases, among others:

United States.-Reagan v. Farmer's Loan & Trust Co., 154 U. S. 362, 38 L. ed. 1014, 14 Sup. Ct. 1047 (1894); San Diego Land & T. Co. v. National City, 174 U. S. 739, 43 L. ed. 1154, 19 Sup. Ct. 804 (1899); Spring Valley Water Works

§1092. The problem of watered stock.

Those who examine into these questions even in the most superficial manner are soon convinced of one thing, and that is that the par value of the outstanding stock issues does not necessarily constitute a proper basis for the capital charge. To make the capital account of a public service company the measure of its legitimate earnings would place, as a rule, the corporation which has been honestly managed from the outset under enormous disadvantages. Little if any weight, therefore, is to be attached to the nominal capitalization of the company, even although these shares may now be in the hands of innocent holders. For, however distressing this circumstance may be, the law must take the attitude that these holders purchased with imputed knowledge of the public service law by which the state may always reduce the rates without unconstitutionality to a point where they will yield no more than a fair return upon actual values. So notorious is it that outstanding securities may have no relation to actual values, that their par value is hardly regarded by anyone to-day.2

v. San Francisco, 124 Fed. 574 (1903); Perkins v. Northern Pac. Ry. Co., 155 Fed. 445 (1908).

California. Spring Valley Water Works v. San Francisco, 82 Cal. 286, 22 Pac. 910 (1890).

Maine.-Kennebec Water Dist. v. Waterville, 97 Me. 185, 54 Atl. 6, 60 L. R. A. 856 (1902).

Minnesota. Steenerson V. Gt. Northern Ry., 69 Minn. 353, 72 N. W. 713 (1897).

North Carolina.-Griffin v. Goldsboro Water Co., 122 N. C. 206, 30 S. E. 319, 41 L. R. A. 240 (1898).

West Virginia.-Coal & Coke Ry.

Co. v. Conley (W. Va.), 67 S. E. 613 (1910).

1 The plight of such holders appealed to Judge Hough in Consolidated Gas Co. v. Willcox, 157 Fed. 849 (1907). But Judge Ross had no sympathy for such holders in San Diego L. & T. Co. v. National City, 74 Fed. 79 (1896).

2 Allegations as to outstanding securities are pertinent. Houston & T. C. Ry. Co. v. Storey, 149 Fed. 499 (1906).

But they are inconclusive. Perkins v. Northern Pacific Ry. Co., 155 Fed. 445 (1908).

For an excellent recent case in

§ 1093. Abandonment of par values.

So disproportionate is capitalization that to some students of the problem who have considered this matter of watered stock attentively it has seemed that the businesslike solution would be to have the shares in the corporation without any designated par value, representing simply fractions of the ownership. This theory has been taken up by practical promoters who frankly admit that the real reason for issuing more in par value than the actual expenditures is so that a return commensurate with the risk may be obtained, should the corporation succeed. The general public however unjustly would almost always object in a particular case to seeing a shareholder getting a fourteen per cent dividend on a $100 share, but not perhaps to his getting a $14 dividend on an undenominated share which he bought for $200. Those who propose thus to elimate par values altogether must of course concede the power of the state to reduce rates so that there shall be no more than a fair return proportionate to the risk upon the actual value of the physical properties at any given time.

§ 1094. Bonded indebtness beyond actual value.

It was at one time supposed that bonded indebtedness was to be held sacred; 1 but from the modern point of view property held in mortgage is subject to revaluation as much as any other. As Mr. Justice Canty said in the leading case of Steenerson v. Great Northern Railway

which it is pointed out that fictitious valuations indicated by over issues of securities are to be rejected in dealing with this problem. See Coal & Coke Ry. Co. v. Conley (W. Va.), 67 S. E. 613 (1910).

In Southern Pacific R. R. Co. v. Bartine, 170 Fed. 751 (1910), it was

said that the fair value of the outstanding securities was one of the elements to be considered.

1 Of the cases to this effect see especially, Chicago & N. W. R. R. v. Dey, 35 Fed. 866, 1 L. R. A. 744 (1888).

Company: "In determining what are reasonable rates, it is perfectly immaterial whether the railroad is mortgaged for two or three times what it would cost to reproduce it, or whether it is free from incumbrance. To hold otherwise would be to hold that the State or the public have indirectly guaranteed the payment of the mortgage bonds of every railroad. The State may as well guaranty the bonds directly as indirectly. But neither the state nor the public have done either the one or the other. It is immaterial how the property has been split up into different rights, interests, and claims. For the purpose of fixing rates, the holders of all these stand in the shoes of the sole owner of the property, unincumbered. The rights of the bondholders are no more and no less sacred than the rights of such an owner."

§ 1095. Stock issues based upon surplus earnings.

Doubts have sometimes been expressed as to the standing of securities issued to stockholders when surpluses have been accumulated. That this process may be stopped for the future by the reduction of rates to a point where no such surplus will be earned is true. But if at some past time a surplus has been earned and either held as cash or utilized in new construction, an issue of new securities against this would seem to represent capital belonging to the stockholders devoted to the business of the company as much as any other securities paid for by their holders. As Mr. Justice Williams clearly explained in the Brymer case: 3 "In determining the amount of the

2

169 Minn. 353, 72 N. W. 713 (1897).

Perhaps the two best cases to read in support of the principal

case are:

United States.-Knoxville v. Knoxville Water Co., 212 U. S. 1, 53 L. ed. 371, 29 Sup. Ct. 148 (1909).

North Carolina.-Griffin v. Goldsboro Water Co., 122 N. C. 206, 30 S. E. 319, 41 L. R. A. 240 (1898).

See Logansport Gas Co. V. Peru, 89 Fed. 185 (1898). 3179 Pa. St. 231, 36 Atl. 249, 36 L. R. A. 260 (1897).