Liability For Watered, Bonus, And Underpaid Shares

• Author: James D. Cox/Thomas Lee Hazen
• Profession: Professor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
• Pages: 420-421

§ 17.1 Varieties of Watered Stock

“Watered stock” refers to shares issued as fully paid when in fact the

consideration agreed to and accepted by the corporation’s directors is

something known to be much less than the par value of the shares or

lawful subscription price. The term is frequently used to cover bonus

shares as well as discount shares and those issued for property or ser-

vices at an overvaluation.

If sh ar es h av e b een is su ed b y a cor po ra ti on a s p ai d i n f ul l wh en in fac t

the subscriber has not paid or agreed to pay the full par value or lawful

issue price, in either money, property, or services, the shares are said to

be watered to the extent to which they have not been, or are not agreed

to be, fully paid. There are various ways in which underpaid or watered

shares may come into being. They may be issued gratuitously without

any consideration passing to the corporation.1 They may be issued for

cash at a discount below par value,2 or i n exc hang e for prope rty, l abor, o r

services that are k now n to be worth less than t he par value.3

Shares may also be issued as a “bonus” or inducement to the pur-

chaser of bonds or preferred shares. Bonus shares are legitimate when

viewed as further consideration for the purchase price that has to be

apportioned between them and the other securities.4 It is often difficult

to allocate or apportion the credit where bonus stock has been issued.

The word “bonus” implies a gift or gratuity and is sometimes used in

the sense of shares issued without any consideration.

Another variety of watered stock may be issued in the guise of a

stock dividend. In such a case, the stock is issued to existing sharehold-

ers as shares that represent a transfer of surplus to capital when in fact

there is insuff icient surplus to justif y their issuance.5

§ 17.2 Evils and Abuses of Stock Watering

Flagrant stock watering was common in the promotion and financing

of corporations in the latter part of t he nineteenth and the early years of

the twentieth cent uries. The evils of stock watering consist prim arily of

injuries to the corporat ion, i nnocent shareholder s, and creditors perpe-

trated by promoters and those in control by depriving the corporation

of needed capital and of the corporation’s opportunity to market its

securities to its own advantage, thus hurting its business prospects and

financial responsibility. Existing and future shareholders are injured

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