The rule charging operating expenses of a railroad, debts due
from it to connecting lines growing out of an interchange of
business, debts due for the occupation of leased lines, and,
generally, debts created under special circumstances which make an
equity in favor of the unsecured debtor, upon the gross income of
the road before a fund arises for the payment of mortgage interest
is not applicable to a fund realized from a sale of the road under
foreclosure of a mortgage, and, as a general rule, unsecured debts
of the company cannot in such case take precedence
Page 125 U. S. 659
over debts secured by prior and express liens in the
distribution of the proceeds of the sale of the mortgaged
property.
The court holds on the proof in this case (1) that no gross
earnings which should have been applied to the payment of the rent
due the appellant were diverted to the payment of interest upon
bonds of mortgage bondholders represented in this suit and
interested in the distribution of the fund, and (2) that the
appellant has no equitable right, as against the appellees, to
priority of payment out of the fund.
The decree appealed from in this case was rendered upon an
intervening petition of the St. Louis, Alton, and Terre Haute
Railroad Company, filed October 30, 1882, in a suit then pending in
the Circuit Court of the United States for the District of Indiana
wherein Hinman B. Hurlbut was complainant and the Indianapolis and
St. Louis Railroad Company defendant, the object of which suit was
to foreclose the second and third mortgages, in which Hurlbut was
the surviving trustee, upon the railroad and other property of the
defendant. A decree of foreclosure and sale had been rendered
therein on May 22, 1882, in pursuance of which the mortgaged
premises were sold on July 28, 1882, for the sum of $1,396,000,
subject to the outstanding first mortgage, and at the date of the
filing of the intervening petition of the present appellant, they
had become by purchase the property of the Indianapolis and St.
Louis Railway Company. The proceeds of the sale were under the
control of the court for purposes of distribution, and the matter
had been referred to a master in chancery to hear evidence in
support of the claims of any creditor claiming the right to share
in that distribution, and to make report thereon.
The petition alleges, and it so appears, that by a decree of the
Circuit Court of the United States for the District of Indiana,
rendered July 26, 1882, in a certain suit in equity, in which said
petitioner was complainant and the said Indianapolis and St. Louis
Railroad Company and others were defendants, he obtained a decree
against said Indianapolis and St. Louis Railroad Company for the
payment of the sum of $664,874.70, besides costs, which decree
remains unsatisfied and unreversed. This amount, it is claimed by
the petitioner, is a lien upon the proceeds of the sale of the
Indianapolis and
Page 125 U. S. 660
St. Louis Railroad, prior in equity to that of the bondholders
secured by the second and third mortgages.
The indebtedness for which this decree was rendered arose under
an agreement entered into between the petitioner and the
Indianapolis and St. Louis Railroad Company on September 11, 1867,
whereby it was provided that the Indianapolis and St. Louis
Railroad Company should manage, operate, and carry on the business
of that portion of petitioner's road known as its principal or main
line, extending from Terre Haute, in the State of Indiana, to East
St. Louis, in the State of Illinois, a distance of 189 miles, and
of the Alton branch thereof, extending from Alton Junction, in the
State of Illinois, to Alton, in said state, a distance of four
miles, for the period of ninety-nine years from the 1st day of
June, 1867; that said Indianapolis and St. Louis Railroad Company
should pay annually during said term to the petitioner thirty
percent of the gross earnings of the said main line and Alton
branch until such gross earnings for the year should amount to
$2,000,000, and twenty-five percent of any excess over $2,000,000,
until the whole earnings for the year should amount to $3,000,000,
and twenty percent of any excess over $3,000,000 of gross earnings
for such year; and further that the said payment should amount in
each and every year to at least the sum of $450,000, which amount
was agreed upon as a minimum rental, to be paid absolutely without
reference to the percentage which if formed of the gross earnings
of any year, and without leaving or creating any claim or charge
upon the earnings of any future year. The petition further shows
that at the time of the execution of the said operating contract,
the Indianapolis and St. Louis Railroad was not built, and that the
Indianapolis and St. Louis Railroad Company was organized and
created for the express purpose of furnishing to the Cleveland,
Columbus, Cincinnati, and Indianapolis Railroad Company and the
Pittsburg, Fort Wayne and Chicago Railway Company a through line to
the Mississippi River by means of its connection with the
petitioner's road, the St. Louis, Alton, and Terre Haute Railroad,
under the foregoing contract, and that while the Indianapolis and
St. Louis Railroad Company
Page 125 U. S. 661
nominally under that contract was the lessee of the petitioner's
road, yet in fact it was leased and operated for the benefit of the
other two companies named, who furnished the money to build the
said Indianapolis and St. Louis Railroad, and who entered into a
contract with the petitioner, guaranteeing performance of said
agreement on the part of the Indianapolis and St. Louis Railroad
Company, and who had entered into a contract between themselves for
the management and operation of the continuous line of railroad
from Indianapolis, in the State of Indiana, to East St. Louis, in
the State of Illinois, including the Indianapolis and St. Louis
Railroad and the petitioner's road. It was further alleged in the
petition that the Pennsylvania Railroad Company, which, together
with the Cleveland, Columbus, Cincinnati, and Indianapolis Railway
Company, are made defendants to the petition, had succeeded to the
rights and obligations under these several contracts and
arrangements of the Pittsburg, Fort Wayne and Chicago Railway
Company; and that the Pennsylvania Railroad Company and the
Cleveland, Columbus, Cincinnati, and Indianapolis Railway Company
were equal owners of the capital stock of the Indianapolis and St.
Louis Railroad Company, and that the Cleveland, Columbus,
Cincinnati, and Indianapolis Railway Company is the holder,
substantially, of all the second mortgage bonds of the Indianapolis
and St. Louis Railroad Company.
The petition further alleges that the eastern terminus of the
St. Louis, Alton, and Terre Haute Railroad is the western terminus
of the Indianapolis and St. Louis Railroad, the two thus forming a
continuous line from Indianapolis to East St. Louis on the
Mississippi River, the road of the petitioner being the only outlet
for the Indianapolis and St. Louis Railroad west of Terre Haute;
that a very large proportion of the earnings of the Indianapolis
and St. Louis Railroad Company are derived from business received
by it from the petitioner's leased line; and avers that the
earnings of the leased road over and above the amount authorized to
be retained by the Indianapolis and St. Louis Railroad Company for
the purpose of operating the same at all times have been and are
the property of the petitioner.
Page 125 U. S. 662
The petitioner further claims that the rental for the use and
occupation of said continuous line constituted a part of the
operating expenses of the Indianapolis and St. Louis Railroad
Company; that the operating contract was executed before any of the
bonds of the Indianapolis and St. Louis Railroad Company were
issued and sold; that it was the duty of the Indianapolis and St.
Louis Railroad Company to pay all of its operating expenses,
including the rental of the petitioner's road, out of its earnings
before it paid any interest on said bonds; but that the said
Indianapolis and St. Louis Railroad Company, instead of paying its
operating expenses as thus defined, diverted and appropriated its
earnings to improvements of its property in better equipment and
new construction, and to the payment of interest upon its bonds,
and neglected and refused to pay the rental accruing to the
petitioner for which it had obtained a decree, as above stated. And
the petition alleges that during the time the Indianapolis and St.
Louis Railroad Company has been in possession of the petitioner's
road, the amount of such misappropriation and diversion of funds
that should have been applied to the payment of operating expenses
amounts to the sum of $1,000,000.
The petition further showed that on May 1, 1878, the
Indianapolis and St. Louis Railroad Company made default in the
payment to petitioner of the rental then due under the terms of
said contract, and so continued to make default from and including
April 1, 1878, up to and including October 26, 1878, during which
time it was in possession and use of the leased road, receiving the
profits and income thereof, and paid over no part of the gross
earnings of said road to the petitioner whatever, but appropriated
the whole of the same to its own use, thirty percent whereof during
said time amounted to the sum of $164,052.82, which, it is alleged,
was appropriated by the Indianapolis and St. Louis Railroad Company
to improvements, betterments, and new construction upon its own
line of railroad, in the purchase of rolling stock and equipment,
and in the payment of interest upon its bonds.
It was further alleged in the petition that when the
Indianapolis and St. Louis Railroad Company took possession of
the
Page 125 U. S. 663
leased road in 1867 it received from the petitioner supplies of
the value of $91,860.05, which, by the terms of the lease, the
lessee contracted and agreed to return or account for to the lessor
at the termination of the lease; that said supplies have long since
been consumed by the lessee; that by the terms of the decree and
sale in the principal cause the lease has been assigned and
transferred to the Indianapolis and St. Louis Railroad Company, and
it is claimed that said amount is a charge upon the proceeds of the
sale of the leased road in the possession of the court for
distribution.
The petition therefore prays for a decree awarding priority in
payment in its favor out of the proceeds of the sale of the two
sums of $664,874.70 and $91,860.05.
To this petition answers were filed by the Cleveland, Columbus,
Cincinnati, and Indianapolis Railway Company, and by the
Pennsylvania Railroad Company, in which the allegations of the
petition in regard to the diversion of the earnings of the St.
Louis, Alton, and Terre Haute Railroad Company to the purposes of
the Indianapolis and St. Louis Railroad are denied, as well as the
general equity set up by the petitioner.
On June 27, 1884, the cause having been fully heard upon the
petition and the answers and proofs, a final decree was rendered
awarding to the petitioner an amount found due to it for rental
accrued while the road was in the possession of the receiver
appointed under the foreclosure proceedings and directing payment
thereof, but so far as the petition sought to establish a claim for
rental prior to the date when the receiver took possession of the
property, as against the proceeds arising from its sale, and so far
as it sought to recover the value of the supplies turned over to
the Indianapolis and St. Louis Railroad Company in 1867, at the
time of the execution of the lease, the petition was dismissed. It
is from that decree that this appeal is prosecuted.
Page 125 U. S. 667
MR. JUSTICE MATTHEWS, after stating the facts as above,
delivered the opinion of the Court.
At the time of the execution of the lease in 1867 of the St.
Louis, Alton, and Terre Haute Railroad to the Indianapolis and St.
Louis Railroad Company, the railroad of the latter company was not
in existence. It was subsequently constructed in order to form the
connection which would give to the parties in interest the desired
through line from Indianapolis to St. Louis. The capital stock of
the Indianapolis and St. Louis Railroad Company was owned
substantially by the Pennsylvania Railroad Company and the
Cleveland, Columbus, Cincinnati, and Indianapolis Railroad Company
in equal parts. A portion of the funds necessary to construct and
equip the road was represented by bonds secured by mortgages. Of
these there were three: the first mortgage was for $2,000,000, the
second for $1,000,000, and the third for $500,000. The first
mortgage bonds, prior to the foreclosure and sale, had
Page 125 U. S. 668
been sold in the market, and were outstanding. The sale was made
subject to the continued encumbrance of that mortgage and of the
bonds secured thereby. The holders of these bonds have, therefore,
no interest in this controversy.
The second and third mortgage bonds were originally taken to
account by the two companies interested in the construction of the
road, but prior to the foreclosure and sale had become
substantially the property of the Cleveland, Columbus, Cincinnati,
and Indianapolis Railway Company, that company having acquired the
entire interest of the Pennsylvania Railroad Company. As the owner
of these bonds, the Cleveland, Columbus, Cincinnati, and
Indianapolis Railway Company claims to be entitled to the whole
amount of the proceeds of the sale of the road under the
foreclosure, and is the only party in interest adverse to the
petitioner.
The default in the payment of interest on the second and third
mortgages dates from January 1, 1878. The decree of foreclosure
finds the amount of interest in arrears on May 2, 1882, on the
second mortgage bonds, to be $291,745.97, and the aggregate sum due
on account of said mortgage, principal and interest, to be
$1,197,745.97, with interest from May 2, 1882. The amount found due
by the same decree on account of the bonds secured by the third
mortgage, including interest from January 1, 1878, is $699,164.76.
The whole amount found due by the decree, including both sums, is
$1,896,910.73, which is more than the amount of the proceeds of the
sale of the road, which were $1,396,000.
Upon the bill of Hinman B. Hurlbut, as trustee, for the
foreclosure and sale of the Indianapolis and St. Louis Railroad
property, a receiver was appointed, and it was ordered that the St.
Louis, Alton, and Terre Haute Railroad Company should be entitled
to require the payment of thirty percent of the gross earnings of
its railroad to said lessor, according to the order of the court
theretofore made and still in force in the suit of the St. Louis,
Alton, and Terre Haute Railroad Company against the Indianapolis
and St. Louis Railroad Company, with the terms of which order the
receiver was directed to comply. The order appointing the receiver
also expressly reserved to
Page 125 U. S. 669
the court the right and power to make such orders and decrees
touching the payment of the debts of the Indianapolis and St. Louis
Railroad Company incurred in the management and operation of its
railroad prior to the appointment of the receiver as might be
equitable and just. The decree of foreclosure and sale also
contained a clause reserving to the court the right by subsequent
order or orders to distribute the proceeds of the sale of the
railroad and property connected therewith, and to make such further
order and decree in regard to the distribution of the proceeds of
sale as might to the court seem equitable and just, and a reference
was made to the master to hear evidence in support of all claims or
indebtedness in behalf of any creditor of the defendant company,
whether secured or not.
The Indianapolis and St. Louis Railroad Company, from the date
of the lease in 1867, continued to pay to the St. Louis, Alton, and
Terre Haute Railroad Company the rental reserved by the terms of
the lease,
viz., thirty percent of the gross earnings of
the leased road in each year until April 1, 1878. Prior to that
time, there had been no default in respect to the payment of the
full amount of the rental as it accrued. The lessee ceased paying
rent from that date.
On October 25, 1878, the St. Louis, Alton, and Terre Haute
Railroad Company filed its bill in equity in the Circuit Court of
the United States for Indiana against the Indianapolis and St.
Louis Railroad Company, to which also the Cleveland, Columbus,
Cincinnati, and Indianapolis Railway Company and the Pennsylvania
Railroad Company were made parties defendant. The object of that
bill was specifically to enforce the performance of the covenants
contained in the lease on the part of the lessee and of the other
defendants as guarantors. It was in that suit that the order was
made November 30, 1878, requiring the Indianapolis and St. Louis
Railroad Company to pay into court, on account of the rental due
the lessor, monthly, on the 15th day of each month, thirty percent
of the gross earnings for the preceding month of the leased road,
calculating the gross earnings which had accrued since October 26,
1878.
Page 125 U. S. 670
The final decree of the circuit court in that cause declared
that the lease and operating contract of September 11, 1867, was a
valid obligation upon all the parties thereto, and established the
amount of the indebtedness of the Indianapolis and St. Louis
Railroad Company on account of the minimum rent reserved by said
lease to July 1, 1882, at the sum of $541,358.23 principal, and
$123,516.47 interest, making in all the sum of $664,874.70. It also
found that thirty percent of the gross earnings of the leased line
collected and received by the Indianapolis and St. Louis Railroad
Company, and withheld by it from April 1, 1878, until October 26,
1878, amounted to $164,052.82, which was part of said aggregate
amount found due. The decree further declared the liability of the
Pennsylvania Railroad Company and of the Cleveland, Columbus,
Cincinnati, and Indianapolis Railway Company as guarantors for
their proportion of the said sum, and awarded payment
accordingly.
From this decree appeals were taken and prosecuted to this Court
by the Pennsylvania Railroad Company and the Cleveland, Columbus,
Cincinnati, and Indianapolis Railway Company, the judgment in which
was rendered at October term, 1885, and is reported in
118 U. S. 118 U.S.
290. It was there decided that the lease of 1867 was void for want
of power on the part of the Indianapolis and St. Louis Railroad
Company to enter into it, and that the guarantee of performance
executed by the other defendant companies by reason thereof was
also void. The decree of the circuit court was accordingly reversed
and the cause remanded with directions to dismiss the bill as to
the Pennsylvania Railroad Company and the Cleveland, Columbus,
Cincinnati and Indianapolis Railway Company, but that part of the
decree which required the Indianapolis and St. Louis Railroad
Company to pay the amount found due as rent was left standing, as
no appeal from it had been prosecuted by the Indianapolis and St.
Louis Railroad Company. Pending that litigation, the intervening
petition of the St. Louis, Alton, and Terre Haute Railroad Company,
now under consideration, was filed in the foreclosure suit, in
which Hurlbut, as trustee, was complainant.
Page 125 U. S. 671
The propositions on which counsel for the appellant bases its
right to the relief prayed for in the intervening petition, and
which was denied by the decree, are stated by it as follows:
First. That the petitioner is in equity entitled to just and
fair compensation for the use of its railroad, equipment, and
franchises as upon
quantum meruit, even if the lease is
entirely disregarded.
Second. That the minimum rent of $450,000 per annum, in monthly
payments of $37,500, is no more than just, fair, and equitable
compensation for the use of the leased line upon quantum
meruit.
Third. That the petitioner is entitled to payment of the
$664,874.70 decreed due it by the decree of July 20, 1882, with
interest thereon, out of the proceeds of the sale of the railroad
and property of the Indianapolis and St. Louis Railroad Company in
preference to payment of the mortgage bonds:
1. Because it is an unpaid
operating expense of the
Indianapolis and St. Louis Railroad Company, there having been
gross earnings abundant to pay all operating expenses, including
rent of the leased line.
2. Because it is a debt justly due to the petitioner as a
connecting line.
3. Because gross earnings lawfully applicable only to operating
expenses, until every operating expense has been fully paid, have
been diverted to the benefit of the bondholders of the petitioner
in payment of bond interest, and in adding increased value to the
mortgaged property by additions and improvements, to an amount
sufficient to have paid the debt now due to the petitioner many
times.
Fourth. That the Cleveland, Columbus, Cincinnati, and
Indianapolis Railway Company, in resisting payment of the debt due
the petitioner in preference to the payment of the second and third
mortgage bonds, does not stand before a court of equity in the
position of simply an ordinary bondholder, and that the peculiar
relations existing between the Cleveland, Columbus, Cincinnati, and
Indianapolis Railway Company and the Indianapolis and St. Louis
Railroad Company, as disclosed by this litigation, greatly
strengthen the
Page 125 U. S. 672
equity in favor of the petitioner in its claim for preference in
payment over the mortgage bonds.
Fifth. That the petitioner is entitled to payment of
$164,052.82, with interest thereon from October 26, 1882, out of
the proceeds of sale, because that amount is thirty percent of the
gross earnings earned on the track of the leased line from April 1,
1878, to October 26, 1878, and is trust money reserved by the lease
belonging to the petitioner, collected, withheld, and wrongfully
appropriated to its own use and benefit by the Indianapolis and St.
Louis Railroad Company.
It may be admitted that the petitioner is entitled in equity to
a just and fair compensation for the use of its railroad by the
Indianapolis and St. Louis Railroad Company, without regard to the
lease, as between it and the lessee, and also that the minimum rent
of $450,000 per annum, in monthly payments of $37,500, is no more
than that just and fair compensation that the lessor company would
be entitled to receive for the use of its road upon a
quantum
meruit. As between the petitioner and the Indianapolis and St.
Louis Railroad Company, the amount of the indebtedness on that
account is conclusively established by the decree of July 26, 1882,
which, as between these parties, stands unreversed and
unsatisfied.
A different question, however, arises as between the petitioner
and the Cleveland, Columbus, Cincinnati, and Indianapolis Railway
Company, as the owner of the mortgage bonds for the satisfaction of
which the Indianapolis and St. Louis Railroad has been sold. It
remains, as between these parties, for the petitioner to establish
that the debt to it of the Indianapolis and St. Louis Railroad
Company, on account of this use and occupation, is a prior lien and
charge upon the proceeds of the sale of the Indianapolis and St.
Louis Railroad, entitled to preference over that of the second and
third mortgages. Among the reasons urged in support of this
preference are these: because the arrearage is an unpaid operating
expense of the Indianapolis and St. Louis Railroad Company, because
it is a debt due to the petitioner as a connecting line, and
because it consists of a portion of the gross earnings earned on
the track of the leased line received by the Indianapolis and
Page 125 U. S. 673
St. Louis Railroad Company and held by it as trust money in
equity belonging to the petitioner. This last reason, as formally
presented, is limited to $164,052.82, being thirty percent of the
gross earnings earned on the track of the leased line from April 1,
1878, to October 26, 1878, but is applicable as well to all other
amounts received by the lessee of the gross earnings of the leased
line which have not been accounted for.
But none of these reasons, standing by themselves, is
sufficient. It is undoubtedly true that operating expenses, debts
due to connecting lines growing out of an interchange of business,
and debts due for the use and occupation of leased lines, are
chargeable upon gross income before that net revenue arises which
constitutes the fund applicable to the payment of the interest on
mortgage bonds. But here there is no question in respect to current
income. The fund in court is the proceeds of the sale of the
property, and represents its corpus, and it cannot be claimed that
ordinarily the unsecured debts of an insolvent railroad company can
take precedence in the distribution of the proceeds of a sale of
the property itself over those creditors who are secured by prior
and express liens.
There are cases, it is true, where, owing to special
circumstances, an equity arises in favor of certain classes of
creditors of an insolvent railroad corporation, otherwise
unsecured, by which they are entitled to outrank in priority of
payment, even upon a distribution of the proceeds of a sale of the
body of the property, those who are secured by prior mortgage
liens. Illustrations and instances of these cases are to be found
in
Fosdick v. Schall, 99 U. S. 235;
Miltenberger v. Railway Co., 106 U.
S. 286;
Union Trust Co. v. Souther,
107 U. S. 591;
Burnham v. Bowen, 111 U. S. 776;
Union Trust Co. v. Illinois Midland Railway Co.,
117 U. S. 434;
Dow v. Memphis & Little Rock Railroad Co.,
124 U. S. 652;
Sage v. Memphis & Little Rock Railroad Co., ante,
125 U. S. 361; and
Union Trust Co. v. Morrison, ante, 125 U. S. 591. The
rule governing in all these cases was stated by CHIEF JUSTICE WAITE
in
Burnham v. Bowen, 111 U. S. 776,
111 U. S. 783,
as follows:
"That if current earnings are used for the benefit of
Page 125 U. S. 674
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."
There has been no departure from this rule in any of the cases
cited. It has been adhered to and reaffirmed in them all.
Admitting, therefore, that the reasonable rent of the leased
line accruing to the petitioner was a proper charge upon the gross
income of the Indianapolis and St. Louis Railroad Company, as a
part of its current operating expenses, before any net income could
arise applicable to the payment of the interest on the mortgage
bonds, it must still be shown, to entitle the petitioner to the
relief prayed for, that the arrearage due on account thereof has
arisen by the diversion and misappropriation of the fund that ought
to have been applied to its payment to the use and benefit of the
mortgage bondholders. Counsel for the petitioner undertake to do
this, and insist that upon the proofs in this case it
satisfactorily appears that such a diversion and misappropriation
have taken place to its injury and to the advantage and benefit of
the bondholders claiming the fund in court for distribution.
This diversion and misappropriation are alleged to have occurred
in two ways: 1st, by the payment of the interest on the mortgage
bonds out of earnings which should have been paid to the petitioner
on account of rent due to it as an operating expense, and 2d, by
the application of earnings to permanent improvements and
betterments of the Indianapolis and St. Louis Railroad property,
which have increased the value of that property as a mortgage
security -- an increased value which, it may be very fairly
presumed, is represented in the proceeds of its sale.
The fact in issue, it is claimed, is shown by an exhibit, which
in tabular form contains a statement of the earnings, expenses,
rental, and interest on bonds of the Indianapolis and St. Louis
Railroad Company, including the leased line as one of its division,
from the date of the commencement of operations under the lease in
1867 to May 23, 1882. That statement shows gross earnings,
$26,868,252.31; operating expenses,
Page 125 U. S. 675
including taxes, $19,417,078.26; leaving as net earnings,
$7,415,174.05. During the same period, the amount of rental paid
for the leased lines was $6,464,869.19, and during the same period
interest paid on bonds, $2,234,396.62, showing as the result of the
operations for the entire period a deficit of $1,248,091.76. It
thus appears that the payments made on account of the various items
mentioned exceed by that sum the entire gross earnings received by
the lessee from its own and the leased line. But inasmuch as during
this period $2,234,396.62 out of the gross earnings were paid on
account of interest on bonds, being $986,304.86 more than the
entire apparent deficit, the inference is drawn that the deficit
has arisen in consequence of the payment of interest on bonds, more
than sufficient, if they had been so appropriated, to have paid the
entire rental, including the arrearage now due. This, it is
claimed, establishes the fact to be proved -- that gross earnings,
which should have been applied to the payment of rent, have been
diverted by the lessee to the payment of interest on bonds.
This statement, however, is deceptive. From the beginning of
operations under the lease in 1867 until April 1, 1878, the
Indianapolis and St. Louis Railroad Company paid in full, as it
accrued, the whole amount of the rental called for by the lease.
During that period, the lessee, being in no default at any time on
account of rent, had a legal right to appropriate any surplus of
its gross earnings to the payment of interest on bonds, or for the
improvement and additional equipment of its road. It was not bound
to accumulate, out of the surplus of gross earnings, prior to 1878,
a fund to meet possible contingencies in respect to rent that might
arise after that date. The petitioner therefore has no right to
complain of any appropriation of the earnings of the leased line
during the period in which it received the full amount due to
it.
If now we turn to a statement of a similar account, beginning in
1878, when the default in the payment of interest began, to the
close of the period, May 23, 1882, we are furnished with the
following figures: gross earnings, $7,443,894.43; operating
expenses, including taxes, $6,253,819.53, leaving
Page 125 U. S. 676
net earnings, $1,190,074.90. During the same period there was
paid on account of rent of the leased line to the petitioner
$1,450,336.67, making a deficit of $260,261.77 without reference to
anything paid during that period on account of interest on bonds.
That is to say, during the period in which the arrearage on account
of rent accrued, there was paid out on account of rent $260,261.77
in excess of the entire earnings of the whole line, after deducting
the ordinary expenses of operation. During the same period there
was paid on account of interest on bonds the sum of $490,105,
making the entire deficit during that period $750,366.77. But it is
admitted that during the same period the Cleveland, Columbus,
Cincinnati, and Indianapolis Railway Company and the Pennsylvania
Railroad Company made advances in cash to the Indianapolis and St.
Louis Railroad Company to the amount of $510,306.24, a sum greater
than the whole amount of the interest paid during the same period
of bonds. Even if we should treat the payment on account of
interest on bonds during that period of $490,105 as taken from the
earnings which should have been applied to the payment of the
rental, it is to be considered that the payment was made on account
of the interest accruing during that period on the first mortgage
bonds alone. No interest whatever was paid from January 1, 1878, on
account of the interest accruing on the second and third mortgage
bonds. It cannot be said that the application of earnings to the
payment of the interest on the first mortgage bonds is chargeable
to the holders of the second and third mortgage bonds; the latter
alone are interested in the fund for distribution. That fund, in
the sense of the rule sought to be applied, cannot be said to have
been benefited by the payment to other bondholders from the gross
earnings applicable to the payment of the rent. The equity of the
petitioner, if in fact it exists, is against the holders of the
first mortgage bonds, who have actually received the money to which
it claims to be equitably entitled.
It is further insisted, however, on behalf of the petitioner
that there has been a diversion of earnings to its detriment by
payments made for additions and improvements to the
Page 125 U. S. 677
mortgaged property during the years 1878, 1879, 1880, and 1881,
amounting to $256,501.05; but if we exclude from the account the
payments made during that period on account of interest on the
first mortgage bonds, as should be done, the amount of these
betterments of the mortgage security is much more than made up by
the cash advances during that period made by the Cleveland,
Columbus, Cincinnati, and Indianapolis Railway company and the
Pennsylvania Railroad Company, which, as we have stated, were
$510,306.24.
A special equity is urged as to the unpaid rent of the leased
line for the seven months from April 1 to November 1, 1878, during
which nothing whatever was paid on that account, amounting, as
found by the decree of July 26, 1882, to $164,052.82, on the ground
that the gross earnings of the leased line during that period were
received by the Indianapolis and St. Louis Railroad Company clothed
with a trust, and were diverted from their legitimate application
to the benefit of the bondholders. As we have already stated, no
equity can arise upon the alleged breach of trust unless the second
and third mortgage bondholders participated in it or have been
benefited by it. The alleged diversion of this amount is covered by
the statements that have been already adverted to. It consists in
payments on account of interest on the first mortgage bonds, which
must be excluded from the account for reasons already given, and
payments made on account of new construction, additions, new
equipment, and improvements, more than covered by the cash advances
made by the owners of the second and third mortgage bonds. An
effort is made in the argument to swell the amount chargeable to
permanent improvements by pointing out that from January 1, 1881,
to May 23, 1882, more than all of the gross earnings of the entire
line were charged up to the operating expense account, without
counting anything for rent of the leased line as an operating
expense. The witness who tabulated the schedules in which these
statements appear stated that during the months covered by these
charges for excessive operating expenses, large improvements were
being made to the property, but no details were brought out on the
examination,
Page 125 U. S. 678
and the witness qualified his statement by saying that he did
not mean to be understood that the improvements were more than such
as were necessary to the proper repair and restoration of the
property. We cannot assume by way of conjecture or mere inference
that the items referred to were not properly charged as operating
expenses. On this branch of the case, we conclude that the
petitioner has failed to establish any diversion and
misappropriation of the earnings applicable to the payment of rent
of the leased line to entitle him in equity to charge the fund in
court for the payment of the arrearage in preference to the second
and third mortgage bondholders.
Independently of the equity growing out of the alleged diversion
and misappropriation of earnings properly applicable to the payment
of rent, it is claimed on behalf of the petitioner that it has an
equitable right to a priority of payment out of the fund in court
growing out of the peculiar relations existing between it and the
Cleveland, Columbus, Cincinnati, and Indianapolis Railway Company
and the Indianapolis and St. Louis Railroad Company, as disclosed
in the transactions out of which this litigation has grown. It is
alleged in substance that the Cleveland, Columbus, Cincinnati, and
Indianapolis Railway Company is the real debtor for this arrearage
of rent; that it with the Pennsylvania Railroad Company were in
fact the owners of the Indianapolis and St. Louis Railroad, which
was built with their money and for the promotion of their interests
in order, by means of the lease of the petitioner's road, to create
a through line from Indianapolis to St. Louis for business between
the East and the West, the establishment and operation of which
have contributed largely to swell the business upon their own
previously existing lines. Having thus induced the petitioner to
enter into the arrangement for their benefit, and having secured
and actually enjoyed its advantages and profits, the argument now
is that good faith, by an equitable estoppel, forbids the
Cleveland, Columbus, Cincinnati, and Indianapolis Railway Company
from now asserting a claim which will deprive the petitioner of the
compensation agreed to be paid
Page 125 U. S. 679
for the use of its road. But this is the very equity which the
petitioner sought to enforce by its bill filed October 25, 1878, in
which it sought to obtain a decree against its lessee and the
guarantors in the lease for the specific performance of the
covenant to pay the reserved rent. In that bill, reliance was
placed, it is true, upon the express covenants which were held
finally to be void; but every equitable ground upon the existing
facts was invoked in support of the validity of the covenants. The
facts supposed to constitute the equity now insisted on were urged
then as sufficient to support the obligation based upon the terms
of the operating contract and lease. If this equity was not
sufficient then to sustain an express promise to pay the rent, it
certainly is not strong enough now to justify a decree for its
payment standing by itself. To enforce the present claim of the
petitioner on this ground would be simply to reinstate as valid the
covenants of the lease and guarantee which between the same parties
have already been finally decided to be void.
It has already been stated that no default occurred in the
payment of the rent by the Indianapolis and St. Louis Railroad
Company until April 1, 1878. After that default occurred, no step
was taken by the petitioner by any legal proceeding to forfeit the
lease and repossess itself of its road. Nothing was done until the
filing of its bill, October 25, 1878, to compel the specific
performance of the covenants of the lease and operating contract,
when the order was made requiring payment to it, pending the
proceeding, of thirty percent of the gross earnings of its road;
and an analysis of the tabular statements, already referred to as
in evidence, shows that the arrearage of rent, for which payment is
now sought, can be recovered only upon the basis of the minimum
rental fixed by the lease by the enforcement of the covenants of
guarantee declared to be void.
The minimum fixed by the lease for the rental of the leased line
from June 1, 1867, to May 23, 1882, at $450,000 per annum, is
$6,750,000; thirty percent of the gross earnings of the leased road
for the same period is $6,031,465.61, being less than the
guarantied rent by $718,534.39. In point of fact, the
Page 125 U. S. 680
condition of the petitioner, upon the facts as they now stand,
without payment of any arrearage of rent, is demonstrably better
than it would have been if no lease had been made and the road had
been operated by its own proprietors independently but as a part of
a connected through line. This is shown by the fact that the lessor
received as rent during the whole period of the lease
$6,464,869.19, while the total net earnings of the leased property
during the same period are shown to have been only $5,290,783.02.
Presumably these net earnings are as large as they would have been
if the road had been operated by its own proprietor. The volume of
its business and the corresponding amount of its gross receipts
were certainly swelled beyond what they would have been if the
Indianapolis and St. Louis Railroad had not been built, or had not
been operated in connection with it. It follows, therefore, upon
the basis of the figures shown in the proofs, that the lessor has
actually received, since the lease was made, in excess of the
entire net earnings of the leased property, $1,174,086.17. Indeed
it is further shown that during the period commencing with 1878,
when the default began, the net earnings of the entire line,
including the Indianapolis and St. Louis Railroad, as well as the
leased road, amounted to $1,190,074.90, and that during the same
period, the lessor received on account of rent $1,450,336.67, being
in excess of the net earnings of the two roads.
Upon these facts, we are unable to discover any equitable ground
for the relief prayed for by the petitioner.
The decree of the circuit court is therefore
affirmed.
