Liability For Watered, Bonus, And Underpaid Shares

AuthorJames D. Cox/Thomas Lee Hazen
ProfessionProfessor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
§ 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 f ull 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 underpa id 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 wor th 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 furt her consideration for the purchase price that has to be
apportioned between them and the other securities.4 It is often dif ficult
to allocate or apportion the credit where bonus stock has been issued.
The word “bonus” implies a gift or grat uity and is sometimes used in
the sense of shares issued without any consideration.
Another variety of watered stock may be issued in the gu ise of a
stock dividend. In such a case, the stock is issued to exist ing sharehold-
ers as shares that represent a transfer of surplus to capital when in fact
there is insuff icient su rplus 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 depriv ing the corporat ion
of needed capital and of the corporation’s opportunity to market its
securities to its own adva ntage, thus hurting its business prospect s and
financial responsibility. Existing and futu re shareholders are injured
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