Legal Definitions - true-value rule

The true-value rule is a fundamental legal principle in corporate law that dictates how much a corporation must receive when it issues shares of stock. It requires that anyone who subscribes for and receives corporate stock must pay at least the stock's "par value" (a nominal value assigned to each share) with actual money or assets that are genuinely worth that amount.

The primary purpose of this rule is to protect the corporation's creditors. By ensuring that the company receives real assets or cash equivalent to the par value of its issued stock, the rule helps guarantee that the corporation's financial records accurately reflect its true capital base. If the actual value paid for the stock (whether in cash, property, or services) is less than its par value, the shareholder may be held personally liable to the corporation's creditors for the difference, even if the company's directors acted in good faith when approving the transaction.

Here are some examples illustrating the true-value rule:

• Example 1: Overvalued Intellectual Property

  A new software startup, "CodeCrafters Inc.," issues 1,000 shares of stock, each with a par value of $5, to its founder, David, in exchange for his proprietary algorithm. The company's board of directors values David's algorithm at $5,000, matching the par value of the shares. Later, CodeCrafters Inc. experiences financial difficulties and declares bankruptcy. During the bankruptcy proceedings, an independent appraiser determines that David's algorithm was only truly worth $2,000 at the time the stock was issued. Under the true-value rule, David would be liable to CodeCrafters Inc.'s creditors for the $3,000 difference ($5,000 par value received - $2,000 true value of the algorithm), because the company did not receive assets equivalent to the full par value of the stock.

• Example 2: Cash Payment Below Par Value

  A struggling retail company, "Bargain Finds Corp.," needs to raise capital quickly. It conducts a private offering, selling 2,000 shares, each with a par value of $20, to an investor named Emily for $15 per share. Emily pays $30,000 in cash ($15 x 2,000 shares). If Bargain Finds Corp. subsequently defaults on its loans and faces liquidation, the true-value rule would apply. Emily would be liable to the company's creditors for the $5 difference per share ($20 par value - $15 cash paid), totaling $10,000 ($5 x 2,000 shares). This is because the company did not receive the full par value in cash for the shares issued, regardless of the board's approval of the lower price.

• Example 3: Overvalued Services Rendered

  "Consulting Pros LLC" issues 500 shares of stock, each with a par value of $10, to a marketing expert, Frank, in exchange for his strategic consulting services. The board values Frank's services at $5,000, which matches the par value of the shares. If Consulting Pros LLC later becomes insolvent, and an investigation reveals that Frank's services, at the time they were rendered, had an objective market value of only $3,500, the true-value rule would come into play. Frank would be responsible to the company's creditors for the $1,500 shortfall ($5,000 par value - $3,500 true value of services), as the company did not receive services equivalent to the full par value of the stock issued.