Legal Definitions - dividend-credit rule

The dividend-credit rule is a principle that states that a company's reserve fund, which is made up of unpaid dividends on preferred stock, must be used to pay subsequent dividends on preferred stock before any dividend payments are made on common stock. This principle is also known as the cast-iron-pipe doctrine.

Let's say a company has both preferred and common stock. The preferred stockholders are entitled to receive a fixed dividend payment each year, while the common stockholders may or may not receive a dividend depending on the company's financial performance. If the company is unable to pay the preferred stock dividend in a given year, the unpaid amount accumulates in a reserve fund. The dividend-credit rule requires that any subsequent dividend payments to preferred stockholders must first be made from this reserve fund before any payments are made to common stockholders.

For example, if a company has $100,000 in its reserve fund and owes $50,000 in unpaid preferred stock dividends, it must use the entire reserve fund to pay the preferred stockholders before any payments can be made to common stockholders. If there is not enough money in the reserve fund to cover the full amount owed to preferred stockholders, the remaining amount will continue to accumulate in the reserve fund until it can be paid in full.