Debts contracted by a railroad corporation as part of necessary
operating expenses (for fuel, for example), the mortgage interest
of the company being in arrear at the time, are privileged debts,
entitled to be paid out of current income if the mortgage trustees
take possession or if a receiver is appointed in a foreclosure
suit.
If the current income of the road is diverted to the improvement
of the property
Page 111 U. S. 777
by the trustees in possession or by the receiver, and the
mortgage is foreclosed without payment of such debts for operating
expenses, an order should be made for their payment out of the fund
if the property is sold, or if a strict foreclosure is had, they
should be charged upon income after foreclosure.
An assignee of such a debt has the same rights as the original
holder.
When commercial paper is the evidence of such a debt, it is no
waiver of the privilege to renew the paper at maturity.
It is not intended to decide that the income of a railroad in
the hands of a receiver for the benefit of mortgage creditors can
be taken away from them and used to pay the general creditors.
The facts are stated in the opinion.
MR. CHIEF JUSTICE WAITE delivered the opinion of the Court.
The facts presented by this appeal are as follows:
On the 1st of June, 1871, the Chicago, Dubuque and Minnesota
Railroad Company executed a trust deed in the nature of a mortgage
conveying all its railroad property and "all the revenues and
income" thereof to John A. Burnham, Stephen V. R. Thayer, and James
H. Blake, trustees, to secure an issue of bonds amounting in the
aggregate to $4,125,000. No interest was paid on these bonds, but
the company remained in peaceable possession and operated its road
until the early part of the year 1875, when the trustees commenced
a suit for the foreclosure of the mortgage in the Circuit Court of
Dubuque County, Iowa, and had a receiver appointed. In the order
appointing the receiver, no special provision was made for the
payment of debts owing for current expenses. The receiver took
possession on the 13th of January, and from that time operated the
road under the direction of the court. When the receiver took
possession, the company was indebted to the Northern Illinois Coal
and Iron Company for coal used in running the locomotives. In the
agreed facts upon which the case was heard below, it is stated that
the coal was furnished during the year 1874, but the precise time
in the year is
Page 111 U. S. 778
not given. From what does appear, however, we are satisfied that
at the time of the appointment of the receiver, this was one of the
current debts for operating expenses made in the ordinary course of
a continuing business, to be paid out of current earnings, and that
the payment would have been made at the time agreed on if the
company had remained in possession. The renewed acceptances, given
after the receiver was appointed, indicate that the originals were
for different amounts, maturing a month apart, thus implying
monthly settlements of monthly accounts, with a somewhat extended
credit to meet the business requirements of what may have been, and
probably was at the time, an embarrassed railroad company.
On the 5th of January, 1876, E. H. Bowen, who was then the
holder of the acceptances, presented a petition to the state court
for the allowance and payment of his claim out of the funds in the
receiver's hands. The claim was allowed, but in connection with the
allowance, the following entry was made:
"This allowance not intended to allow or establish any lien, but
simply to allow them [the acceptances] to be presented and
determined as to their rights of payment on final hearing."
After this was done, the cause was removed to the Circuit Court
of the United States for the District of Iowa and docketed there on
the 11th of January. The receiver appointed by the state court
continued in possession and operated the road until June 23, 1876,
when another was put in his place. The net earnings of the road
while in the hands of the receivers amounted to more than
$25,000.
In 1871, the company purchased lands in Dubuque for its depot
and offices and secured the purchase money by a mortgage on the
property. This debt being unpaid, a suit for the foreclosure of the
mortgage was begun which resulted in a decree of sale on the 5th of
June, 1876, to pay the amount due, being $7,898. By order of the
circuit court of the United States, this amount was paid from the
earnings of the receivership in monthly installments, beginning on
the 5th of June and ending on the 4th of September, 1876. In
addition to this, $14,897.94 was paid on a judgment rendered
against the company January 8, 1875, for the right of way over
certain
Page 111 U. S. 779
property in Brownsville. Of this amount, $5,000 was paid June
28, and the remainder November 1, 1876. Other judgments for rights
of way, amounting in the aggregate to $3,020.55, were paid, some in
1875 and others in 1876.
On the 28th of October, 1876, a decree was entered in the suit
for the foreclosure of the trust mortgage, finding due upon the
bonds $5,980,166 and barring the redemption if payment of this
amount was not made in ninety days. It was also further ordered
that the trustees have immediate possession of the mortgaged
property from the date of the decree and of the net income from the
commencement of the suit. The decree also contained this
provision:
"It is further decreed that this cause, with all the matters in
controversy between the plaintiffs and all and any of the
defendants and intervenors and claimants, is continued until the
next term of this Court, and such rights and claims and matters in
controversy are in nowise affected or determined by this
decree."
Default was made in the payment of the mortgage debt, and the
property was put into the possession of the trustees by the
receivers under the decree of strict foreclosure. Among the
property which went into the hands of the trustees under this
decree were the depot and offices in Dubuque, which had been
relieved of encumbrance by the payments from the income of the
receivership and the several rights of way also paid for from the
same fund.
The original petition of intervention filed in the cause by
Bowen, the appellee, for the payment of his acceptances for coal,
was lost from the files, and on the 18th of October, 1878, on leave
of the court, another was substituted in its place, asking that a
judgment might be rendered in his favor against the railroad
company for the payment of the amount due "and that such judgment
be declared a lien on the property and road of said company in the
hands of said trustees and their grantees." On the 13th of October,
1880, a decree was entered finding due Bowen, on his claim, as of
that date, the sum of $6,515.42, and declaring that the mortgaged
property in the hands of the trustees under the decree of
foreclosure was
Page 111 U. S. 780
equitably bound for the payment thereof,
"said property having passed to said trustees, subject to the
rights and equities of said Bowen, intervenor, and said trustees,
and all parties holding under them, taking said property subject to
such rights and equities on part of said Bowen, intervenor."
Provision was then made for a sale of the property if the claim
was not paid. From this decree the trustees appealed.
In our opinion, the view which the circuit court took of this
case was the correct one. The company had never paid its bonded
interest. From the very beginning it was in default in this
particular, yet the mortgage trustees suffered it to keep
possession and manage the property. The maintenance of the road and
the prosecution of its business were essential to the preservation
of the security of the bondholders. The business of every railroad
company is necessarily done more or less on credit, all parties
understanding that current expenses are to be paid out of current
earnings. Consequently it almost always happens that the current
income is encumbered to a greater or less extent with current debts
made in the prosecution of the business out of which the income is
derived.
As was said in
Fosdick v. Schall, 99 U. S.
235,
99 U. S.
252,
"The income [of a railroad company] out of which the mortgagee
is to be paid is the net income obtained by deducting from the
gross earnings what is required for necessary operating and
managing expenses, proper equipment, and useful improvements. Every
railroad mortgagee, in accepting his security, impliedly agrees
that the current debts made in the ordinary course of business
shall be paid from the current receipts before he has any claim on
the income."
Such being the case, when a court of chancery, in enforcing the
rights of mortgage creditors, takes possession of a mortgaged
railroad, and thus deprives the company of the power of receiving
any further earnings, it ought to do what the company would have
been bound to do if it had remained in possession -- that is to
say, pay out of what it receives from earnings all the debts which
in equity and good conscience, considering the character of the
business, are chargeable upon such earnings. In other words, what
may properly be termed the debts of the income should
Page 111 U. S. 781
be paid from the income before it is applied in any way to the
use of the mortgagees. The business of a railroad should be treated
by a court of equity under such circumstances as a "going concern,"
not to be embarrassed by any unnecessary interference with the
relations of those who are engaged in or affected by it.
In the present case, as we have seen, the debt of Bowen was for
current expenses and payable out of current earnings. It does not
appear from anything in the case that there was any other liability
on account of current expenses unprovided for when the receiver
took possession, and there is nothing whatever to indicate that
this debt would not have been paid at maturity from the earnings if
the court had not interfered at the instance of the trustees for
the protection of the mortgage creditors.
It is said, however, that as no part of the income before the
appointment of the receiver was used to pay mortgage interest or to
put permanent improvements on the property or to increase the
equipment, there was no such diversion of the funds belonging in
equity to the labor and supply creditors as to make it proper to
use the income of the receivership to pay them. The debt due Bowen
was incurred to keep the road running, and thus preserve the
security of the bond creditors. If the trustees had taken
possession under the mortgage, they would have been subjected to
similar expenses to do what the company, with their consent and
approbation, was doing for them. There is nothing to show that the
receiver was appointed because of any misappropriation of the
earnings by the company. On the contrary, it is probable, from the
fact that the large judgment for the right of way was obtained
about the same time the receiver was appointed, that the change of
possession was effected to avoid anticipated embarrassments from
that cause. But however that may be, there certainly is no
complaint of diversion by the company of the current earnings from
the payment of the current expenses. So far as anything appears on
the record, the failure of the company to pay the debt to Bowen was
due alone to the fact that the expenses of running the road and
Page 111 U. S. 782
preserving the security of the bondholders were greater than the
receipts from the business. Under these circumstances, we think the
debt was a charge in equity on the continuing income as well that
which came into the hands of the court after the receiver was
appointed as that before. When, therefore, the court took the
earnings of the receivership and applied them to the payment of the
fixed charges on the railroad structures, thus increasing the
security of the bondholders at the expense of the labor and supply
creditors, there was such a diversion of what is denominated in
Fosdick v. Schall the "current debt fund" as to make it
proper to require the mortgagees to pay it back. So far as current
expense creditors are concerned, the court should use the income of
the receivership in the way the company would have been bound in
equity and good conscience to use it if no change in the possession
had been made. This rule is in strict accordance with the decision
in
Fosdick v. Schall, which we see no reason to modify in
any particular.
But it is further insisted that even though the court did err in
using the income of the receivership to pay the fixed prior charges
on the mortgaged property, and thus increase the security of the
bondholders, there is no power now to order a sale of the property
in the hands of the trustees to pay back what has thus been
diverted. In
Fosdick v. Schall, p.
99 U. S. 254,
it was said that if in a decree of foreclosure, a sale is ordered
to pay the mortgage debt, provision may be made for a restoration
from the proceeds of the sale of the fund which has been diverted,
and this clearly because, in equity, the diversion created a charge
on the property for whose benefit it had been made. Here, the
parties interested preferred a decree of strict foreclosure, which
the court gave, but in giving it saved the rights of all
intervenors and continued the case for the final determination of
all such questions. The present appeal is from a decree which grew
out of this reservation. As the diversion of the fund created in
equity a charge on the property as security for its restoration, it
is clear that if the mortgagees prefer to take the property under a
decree of strict foreclosure, they take it subject to the charge in
favor of the
Page 111 U. S. 783
current-debt creditor whose money they have got, and that he can
insist on a sale of the property for his benefit if they fail to
make the payment without. The agreed facts show that $9,897.94 of
the income of the receivership was paid on the judgment for the
right of way November 1, 1876, which was after the decree of strict
foreclosure was entered.
Lastly, it is claimed that the appellee is barred by his laches,
and because he is the assignee of the original creditor. It was
decided in
Union Trust Company v. Walker, 107 U.
S. 596, that the assignment of a claim of this kind
carried with it the right of the original holder to claim payment
out of the fund upon which it is charged. When the receiver was
appointed, the debt was evidenced by business paper maturing at a
future date. It was no waiver of any claim on the fund which might
come into the hands of the receiver to renew the paper at maturity
for the convenience of the holder. It was undoubtedly given
originally to enable the coal company to use it as commercial paper
if occasion required, and the renewal may have become desirable on
account of the use which had been made of it. The original petition
of intervention was not filed until January 5, 1876, but it was
before any application of the income of the receivership for the
special benefit of the mortgagees, and before the decree of
foreclosure was passed and the rights of the intervenor were saved
by that decree. The petition was pending from the time it was
filed. The loss of the original petition did not abate the suit.
The substitution of the new petition for the old was nothing else,
in effect, than a restoration of the lost paper to the files.
We do not now hold, any more than we did in
Fosdick v.
Schall or
Huidekoper v. Locomotive Works,
99 U. S. 260,
that the income of a railroad in the hands of a receiver, for the
benefit of mortgage creditors who have a lien upon it under their
mortgage, can be taken away from them and used to pay the general
creditors of the road. All we then decided and all we now decide is
that if current earnings are used for the benefit of mortgage
creditors before current expenses are paid, the mortgage security
is chargeable in equity with the restoration of the fund which has
been thus improperly applied to their use.
The decree of the circuit court is affirmed.