In a decree for the foreclosure and sale of a railroad property
under a mortgage, power was reserved by the court to compel the
purchaser to pay any and all receivers' debts or claims adjudged or
to be adjudged as prior in lien or equity to the mortgage debts or
entitled to preference in payment out of the proceeds of sale.
Held that the rights of creditors whose claims had been
filed were not affected by the sale of the property or by the fact
of its transfer to the purchaser, nor did the reservation in the
order of sale prevent the purchaser from contesting upon their
merits any claims allowed after the purchase under the decree of
sale.
A railroad mortgagee, when accepting his security, impliedly
agrees that the current debts of a railroad company contracted in
the ordinary course of its business shall be paid out of current
receipts before he has any claim upon such income, that, within
this rule, a debt not contracted upon the personal credit of the
company, but in order to keep the railroad itself in condition to
be used with reasonable safety for the transportation of persons
and property, and with the expectation of the parties that it was
to be met out of the current receipts of the company, may be
treated as a current debt, that whether the debt was contracted
upon the personal credit of the company, without any reference to
its receipts, is to be determined in each case by the amount of the
debt, the time and terms of payment, and all other circumstances
attending the transaction, and that, when 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 funds thus improperly diverted from their
primary use.
Page 176 U. S. 258
A general unsecured creditor of an insolvent railroad
corporation in the hands of a receiver is not entitled to priority
over mortgage creditors in the distribution of net earnings simply
because that which he furnished to the company prior to the
appointment of the receiver was for the preservation of the
property and the benefit of the mortgage securities. Before such a
creditor is accorded a preference over mortgage creditors in the
distribution of net earnings in the hands of a receiver of a
railroad company, it should reasonably appear from all the
circumstances that the debt was one to be fairly regarded as part
of the operating expenses of the railroad incurred in the ordinary
course of business, and to be met out of current receipts.
This case is here upon a writ of certiorari for the review of a
final decree of the United States Circuit Court of Appeals for the
Fourth Circuit allowing certain claims of the Carnegie Steel
Company, Limited, as preferential debts chargeable upon current
receipts arising from the operation of certain railroad properties
in the hands of receivers.
On the 15th day of June, 1892, William P. Clyde, John C. Maben,
and William H. Goadby, citizens of New York, suing for themselves
and other creditors and stockholders of the Richmond and Danville
Railroad Company and of other defendant corporations, exhibited in
the Circuit Court of the United States for the Eastern District of
Virginia a bill of complaint against the Richmond and Danville
Railroad Company and the Richmond & West Point Terminal Railway
& Warehouse Company, Virginia corporations. The bill made the
following case:
The Richmond and Danville Railroad Company (hereafter called the
Danville Company), in addition to its own line extending from
Richmond to Danville, with a twelve-mile branch, being 152 miles of
road, through the purchase or the acquisition of stock, or by
written lease or operating contracts, obtained the possession and
control of more than twenty other railways built under the
respective charters of and owned by the corporations named in the
bill. It also owned the entire capital stock of the Baltimore,
Chesapeake & Richmond Steamboat Company, and through it
operated a line of steamers between Richmond, West Point, and
Baltimore. Its authorized and outstanding capital stock was
five
Page 176 U. S. 259
million dollars, the larger part being owned by its codefendant
company.
The lines of railway comprising this system, known as the
Danville system, were in Virginia, North Carolina, South Carolina,
Georgia, Alabama, and Mississippi, and reached many of the most
important trade centers of those states.
For more than five years prior to the institution of that suit,
the Danville Company had held in possession and substantial control
all the railways of the other companies in connection with its own
road as a single system. Over a large portion of the mileage, the
engines and cars in traffic service were used without any fixed
apportionment thereof to any specific portion of the system, and
the income derived from the operations of the parent and auxiliary,
leased, and operated liens was received and distributed through a
common treasury, with no separation of the earnings and expenses of
the several properties except by entries in books of account
apportioning the gross income and expenses on some approximate but
arbitrary basis of division as between the different lines over
which the traffic yielding the revenue had passed.
The total mileage of the auxiliary portion of the Danville
railroad, added to its own mileage, aggregated 3,320 miles,
exclusive of its steamer service.
The aggregate outstanding capital stock of the lines
constituting the system, together with the stock of the steamboat
company, amounted to $43,482,950, of which $10,707,354 was neither
owned nor controlled by the defendant companies.
Through the ownership of all or a majority of the stock thereof,
some of the roads were operated by the Danville Company as
proprietary lines. Others were operated upon the basis of a fixed
rental or payment of net earnings, or a guarantee of interest on
bonds or dividends of stock, or both.
In consequence of the absorption of such roads in its system by
lease or contract, the bonded debts and rental obligations which
the Danville Company had assumed and became liable for amounted to
$71,128,126. Its own direct bonded debt was $16,136,000, making the
total bonded and rental debt of the Danville system
$87,314,126.
Page 176 U. S. 260
The bonded debt resting on the Danville road proper and
equipments was in five separate issues of securities; that resting
on its auxiliary and operative lines was embraced in fifty-nine
different classes of securities issued by the several companies,
secured by separate mortgages or deeds of trust covering different
sections of the controlled roads or their equipment, capable of
separate default or foreclosure, besides five stock guaranties,
representing certain of its rental obligations, also secured by
provisions for reentry on default.
The Danville Company also had outstanding car trust obligations
of its own and leased lines amounting to $1,542,824, and a floating
debt of over $5,000,000; also an emergency loan of $600,000,
advanced by those interested in the property to prevent default on
April 1, 1892.
Besides all such outstanding fixed liabilities on account of its
own road and controlled lines, the directors of the Danville
Company had pledged its credit and subjected it to other heavy
liabilities, to enable its codefendant, the Richmond & West
Point Terminal Railway & Warehouse Company (to be hereafter
referred to as the Terminal Company) or certain of its controlled
companies to acquire the stock control of other lines of railroads
not directly connected with or operated by the Danville Company and
in which it had no interest whatever. Its board of directors had
issued $6,000,000 of bonds of the Danville Company, executed
jointly and severally with the East Tennessee, Virginia &
Georgia Company, and guaranteed by the Terminal Company "Cincinnati
Extension Bonds," which were secured by a trust pledge of
preference and ordinary shares of the Alabama & Great Southern
Railway Company, Limited. Those bonds had been sold in open market,
and apparently constituted an outstanding liability of the Danville
Company, but for which it received no valuable consideration
whatever. It had executed the same as mere accommodation paper and
as a partnership adventure, and was only protected against loss by
the above pledge of corporate stock of uncertain value, because it
was subject to heavy prior mortgage debts, and the line of road of
the particular corporation issuing such stock was a
Page 176 U. S. 261
central link in the system of the East Tennessee Railway system
over which the Danville Company had no control whatever.
By reason of the absolute stock control which the Terminal
Company had over the Danville Company, it compelled the latter
company, about June 1, 1891, to become the assignee and guarantor
of a written lease executed by the Central Railroad & Banking
Company of Georgia, of all its system of railroads and steamer
lines for a long-term of years to the Georgia Pacific Railway
Company, whereby the Danville Company became bound to operate the
Central System and to assume and pay all the interest on the bonded
debts and all the rental obligations of the Central Railroad &
Banking Company, and the Danville Company was compelled to execute
and deliver a bond of $1,000,000 to faithfully perform all the
covenants in such lease. The result of the operation of the
Central-Georgia system of roads had been a constant and heavy loss
to the Danville Company.
The bill next set out the relations between the Danville Company
and the Terminal Company, and also describes what is known as the
Tennessee system, having 2,318 miles in length of proprietary,
leased, and operated roads.
It then stated that the five several issues of bonds of the
Danville Company were secured by mortgages to divers trustees, and
constituted liens of varying rank upon some portion of its road,
franchises, and equipment; that the bonds issued by the Danville
and Terminal Companies, as well as a large majority of the several
issues of bonds resting on the different separately mortgaged
sections of the Danville system, were owned by a large and
constantly shifting number of persons and corporations, who were
scattered in many different states and countries and had no
organization or registration; that what was known as the emergency
loan, for which the income of the Danville system was pledged, was
advanced in equal sums by a considerable number of persons, many of
whom preferred not to have their names or advances disclosed; that
the plaintiff, Maben, was a registered stockholder of the Danville
Company; that the plaintiffs were
Page 176 U. S. 262
owners of a large amount of the common preferred stock of the
Terminal Company and of its six and five percent bonds, of the
Danville Company's debenture and five percent bonds, and of
different classes of bonds resting on parts of the Danville system,
and some of them were creditors of the Danville Company on account
of advances made to the emergency loan, and entitled to the
security given therefor; that, while nominally distinct
corporations, the actual transactions and financial arrangements
between the Terminal Company, conducting no active business as a
security company, with no assets except stocks and bonds (but
holding nearly the entire capital stock of the Danville Company)
and the Danville Company, as a corporation operating a large system
of railways, separately organized and mortgaged, had resulted in
serious complications; that such community of heavy and extra
hazardous liability and hypothecation indissolubly connected the
financial operations of the Danville and Terminal Companies, so
that the unrelieved embarrassment of either company would
necessarily force the insolvency of the other, "and produce a
disruption of the system of roads;" that the then financial
condition of the two defendant corporations was alarming to the
holders of their stocks and bonds; that in the latter part of 1891,
the large and increasing floating debts of the several properties
in which the Terminal Company was interested and the heavy losses
incurred in the operations of some of the roads created much
uneasiness among the stockholders and creditors; that, by reason of
such condition of things, the management had invited prominent
financiers to investigate the several systems and aid in perfecting
the best plan for permanently adjusting the affairs of the
companies in question and secure them the credit necessary for
their successful operation; that two movements to that end had
failed, when about the last of May, 1892,
"a large number of security holders joined in a request to an
eminent banking firm of New York city that it should investigate
the property and its financial condition, and undertake to rescue
it from the bankruptcy, shrinkage in value, and disruption with
which the system was threatened;"
that such bankers consented to cause an examination
Page 176 U. S. 263
to be made, and the plaintiffs were advised that the same was in
progress, but that no conclusion had been reached or report made,
and necessarily the creditors and security holders were so
numerous, scattered, and unknown, and the classes of liens so
varied in character and value, that to perfect any satisfactory
plan to reorganize the system and secure the necessary creditors'
assent would require considerable time, and that in the meantime
the financial embarrassments continued to be urgent and
threatening, and the possible consequence thereof might "result in
the disruption of the system, and the depreciation of millions of
dollars in the value of the securities."
The bill further alleged that the enormous floating debt of the
Danville Company was wholly beyond its financial ability to carry
out of its ordinary revenues, over $4,500,000 of such debt standing
in demand loans subject to summary enforcement; that, by reason of
the depreciation in the market value of its securities and the
failure of the several efforts to reorganize the property, its
credit had been much impaired; it was not able to pay its
obligations as they matured, but had been forced to ask renewals;
it had no available collaterals to enable it to negotiate such a
loan as was necessary to adequately protect it against open
default; it had been forced to postpone payment of usual operating
expense vouchers for supplies, and was allowing heavy arrears of
such debts to accrue; many creditors had brought suits and attached
cars and funds forwarded to pay employees; besides its floating
debt, mortgage coupons on seventeen sectional mortgages,
aggregating $989,000, would fall due on July 1, 1892; it had no
available money or assets wherewith to pay the debts which would
soon mature and no reasonable hope of financial assistance from any
quarter to enable it to do so; its directors had had no meeting for
over two months, and had practically abdicated their trust and
power of management and confessed their utter inability ability to
devise means to divert the insolvency and disruption of the system
in their charge.
Plaintiffs charged that the corporation was insolvent and
Page 176 U. S. 264
this vast trust property was substantially derelict; that the
unity of the property, as held and operated as an important trunk
line, constituted one of the most important ingredients of its
value, and that to permit its severance would result in a ruinous
sacrifice to every interest in the property; that the owned and
operated lines of road lie in six states, and were subject to the
jurisdiction of the courts in each of the many counties in which
the property was situate; that, unless the court, in view of the
impending and inevitable defaults as aforesaid, would deal with the
property as a single trust fund, and take it into judicial custody
for the protection of every interest therein, individual creditors,
immediately upon default, would assert their remedies in different
courts in the several states; that a race of diligence would
result, and judgments and priorities attempted; that levies and
attachments would be laid upon the engines and cars of the company,
and upon the fuel, material, and supplies indispensable to the
operations of the road, and which would greatly interfere and
ultimately prevent the company from properly discharging its duties
as a public carrier and seriously diminish the earnings of the
road; that lessors of the roads now owned would enforce the reentry
covenants of their leases; that the continued default of the
mortgaged debts would produce the immediate maturity of the bonds,
and that
"a vast and unnecessary multiplicity of suits will result, and a
most important and valuable trust property will be dismembered by
the clashing decrees of the many courts exercising jurisdiction at
the suit of separate creditors, which might be shielded and
preserved as a valuable single trust property by adequate judicial
protection until such time as a satisfactory financial
reorganization could be perfected."
The plaintiffs also averred
"that the Central Trust Company is not only the trust depository
in the said pledge of income, but is the trustee in over twelve
trust deeds executed by the Danville Company and divers roads in
its system, and also trustee for the preferred stockholders and six
percent and five percent trust deeds of the Terminal Company. That
the trusts and duties in said different deeds as to property,
equipment, and income
Page 176 U. S. 265
are variant and in some respect antagonistic. In case of default
and judicial enforcement, their reciprocal rights will have to be
construed and decreed by the court, and such common trustee cannot
properly represent such variant trusts, and the bondholders have
the equity to apply in their own names to protect the trust
estate."
The relief asked was --
That the court would decree that the plaintiffs as holders of
aliquot portions of the emergency loan to the Danville Company,
guaranteed by the Terminal Company, had a fixed and specific lien
upon all and singular the income, tolls, and revenues of the
Danville Company and its leased, operated, and controlled
railroads, and each of them, and that the condition of such pledge
of income had been broken, entitling the holders of such
indebtedness to enforcement thereof;
That the court would also administer the trust fund in which the
plaintiffs were interested, constituting the entire railroad and
assets of the defendant corporations, and would for that purpose
marshal all their assets and ascertain the respective liens and
priorities existing upon every part of such system of railways, the
amount due upon mortgages and other liens, and enforce and decree
the rights, liens, and equities of each and all of the stockholders
and creditors of the Danville and Terminal Companies as the same
were finally ascertained and decreed, in and to not only those
lines of railroads, appurtenances, and equipments, but also to and
upon every portion of the assets and property of each of those
corporations; and --
That for the purpose of enforcing a lien and equity upon the
income of the railroad system aforesaid to which the holders of the
emergency loan were by contract entitled, "as well as to preserve
the unity of said system" as it had been for years maintained and
operated, and preventing the disruption thereof by separate
executions, attachments, or sequestrations, the occurrence of which
would be inevitable in view of the defaults in interest payments
which would presently occur, the court would forthwith appoint one
or more receivers of the entire system of railroads and steamers
held and operated by the Danville Company, together with all
equipment,
Page 176 U. S. 266
material, machinery, supplies, moneys, accounts, choses in
action, and assets of every description and wherever situated,
together with all leasehold rights and contracts, with authority to
manage and operate the same as the officers of and under the
direction of the court, and that all the officers, managers,
superintendents, and employees of the Danville Company be required
to forthwith deliver up the possession of all and singular each and
every part of the property over which the receivers were thus
appointed, wherever situate, and also all books of accounts,
offices, vouchers, and papers in any way relating to the business
or operation of such system of railways and steamers, and for
injunctions restraining each and every of the officers, directors,
managers, superintendents, agents, and employees of the Danville
Company from interfering in any way whatever with the possession
and control of the receivers over any part of the property.
Upon hearing and considering the bill, with the exhibits and
answer in support thereof, and on motion of the complainants,
Frederic W. Huidekoper and Reuben Foster were appointed by the
court receivers of the property and assets of the Danville Company
-- namely, the system of railways then in the possession of and
owned and controlled by that corporation, situated in the District
of Columbia and in the states of Virginia, North and South
Carolina, Georgia, Alabama, and Mississippi, together with all the
equipments, shops, appurtenances of every kind, machinery,
material, and supplies owned, held, or in the possession and use of
such corporation, wherever situate, including all tracks, terminal
facilities, real estate, warehouses, offices, stations, and all
other buildings of every kind, owned, held, or possessed by the
Danville Company, together with all steamers, wharves, and other
properties held in connection therewith, and all moneys, choses in
action, credit, bonds, stocks, leasehold interests, or operating
contracts, and other assets of every kind, and all other property,
real, personal, and mixed, owned, held, or possessed by that
company.
It was further provided in the order of the court that the
receivers
"shall from time to time, out of the funds, coming
Page 176 U. S. 267
into their hands from the operation of the property, pay the
expense of operating the same and executing their trusts, and all
taxes and assessments upon the said property or any part thereof,
and also pay and discharge all such traffic and car mileage
balances as may be due to connecting and other railways, and all
such loss and damage claims arising from the previous operation of
said property as, in their judgment, on examination, are proper to
be paid as expenses of operation, and shall also, out of the moneys
coming into their hands, pay and discharge all the current unpaid
payrolls and vouchers and supply accounts incurred in the
operations of said railroad system at any time within six months
prior hereto."
The receivers, who are referred to in the record as the
insolvency receivers, entered into full and exclusive possession on
the 16th day of June, 1892.
On that and the succeeding day, auxiliary suits were instituted
by the plaintiffs against the Danville Company in the Circuit
Courts of the United States for the Western District of North
Carolina, the District of South Carolina, the Northern District of
Georgia, the Northern District of Alabama, and the Northern
District of Mississippi, and orders were duly entered of record by
each of those courts confirming the original appointment of
receivers and recognizing the Circuit Court of the Eastern District
of Virginia as having primary jurisdiction over all the railroad
system and property of the Danville Company, wherever situated.
On the 28th day of June, 1892, the plaintiffs filed a petition
in the cause, stating that the Central Trust Company of New York
was trustee in five mortgages executed by the Danville Company,
resting upon its property, and of the following dates and amounts:
October 5, 1874, $5,997,000; February 1, 1882, $3,368,000; October
22, 1886, $4,498,000; September 3, 1889, $1,390,000; May 1, 1891,
$883,000. The petitioners prayed that the receivers be authorized
to execute and sell receivers' certificates to an amount not
exceeding $1,000,000, which should be a first lien on the Richmond
and Danville Railroad, its property, leasehold interests,
contracts, and income,
"and out of the proceeds, as a special fund, to pay and
Page 176 U. S. 268
discharge all outstanding indebtedness of the Danville Company
incurred for material and supplies in the operation of the roads in
the receivers' hands, which were purchased within six months prior
to June 15, 1892, as the said indebtedness shall be ascertained and
reported on by special masters to be appointed for such purpose,
and also that out of the funds coming into their hands from the
operation of the roads which could be safely used without prejudice
to their own current liabilities for operating expenses, the
receivers be authorized to pay the installments of rent and coupons
of mortgage bonds resting 'upon the several parts of the system, so
as to protect and preserve the present unity of the system of roads
in their charge.' The petition concluded:"
"The Central Trust Company is the trustee in each and all of the
trust deeds and mortgages, and it is made a party hereto so that it
can appear to the application and be heard upon the question of
using receivers' certificates and authorizing the payment of
mortgage, interest, and rental obligations out of the current net
income of the receivership."
Of the application for an order in accordance with the petition
the defendants and the Central Trust Company had notice. The court,
by order, authorized the borrowing of $1,000,000 receivers'
certificates to be used for the purposes indicated in the petition.
The Trust Company was represented at the hearing of the
application, and, so far as the record discloses, made no objection
to the order.
On the 13th day of July, 1892, the Central Trust Company
presented its petition and prayed that it be allowed to intervene
in the suit brought by Clyde and others for the protection of the
holders of the six percent bonds of the Danville Company and of the
subscribers to the emergency loan made prior to April 1, 1892, and
in respect of which that company was the trust depositary of the
income of the Danville system pledged to secure such loan, and by
order entered August 16, 1892, leave was given for that company to
intervene in the cause, "on the condition that it hereby submits to
the several orders heretofore entered herein." On the latter day,
that company presented its petition, asking that Huidekoper
Page 176 U. S. 269
and Foster be appointed as permanent receivers of the Danville
Company if the court should determine to continue its judicial
possession of the system. An order to that effect was accordingly
made. In presenting the above petition, the Central Trust Company
appeared not only as trustee of the Richmond and Danville Railroad
Company and the consolidated gold mortgage, to be presently
referred to, but as trustee representing other mortgages and
railroads, including the Virginia Midland Railroad, the Georgia
Pacific Railway, and the North Eastern Railroad of Georgia.
On the 19th day of December, 1892, an intervening petition was
presented by parties representing the underlying bondholders
interested in any litigation or proceedings for the foreclosure of
any of the mortgage or trust deeds of the Danville Company or any
of the companies forming a part of the Danville system, and they
were permitted to become come parties complainant in the Clyde
suit, and to file such petitions and take such proceedings as they
deemed necessary or requisite for the protection of the interests
they represented.
In the suit instituted by Clyde and others, the Carnegie Steel
Company, Limited, filed with the Master Commissioner, October 14,
1892, its claims arising out of certain contracts made between that
company and the Danville Railroad Company in 1891 for steel rails
delivered to the latter between July 25, 1891, and October 10,
1891. The facts relating to those contracts will be hereafter
stated.
On the 13th day of April, 1894, the Central Trust Company of New
York instituted a separate suit against the Richmond and Danville
Railroad Company for the foreclosure of what is known as the
consolidated gold mortgage. Upon the filing of that petition and on
the motion of the Trust Company, an order was entered appointing
Huidekoper, Foster, and Spencer receivers of the court of all and
singular the railroads, property, assets, credits, and effects of
the Richmond and Danville Railroad Company,
"the same being the system of railways owned, operated, or
controlled by the said corporation, situate in the District of
Columbia and in the States of Virginia, North Carolina, South
Carolina, Georgia, Alabama, and Mississippi,
Page 176 U. S. 270
together with all the equipment, shops,"
etc.,
"and other assets of every kind, and all other property, real,
personal, and mixed, held or possessed by the said railroad
company, the above-mentioned property being now in the possession
of said Frederic W. Huidekoper and Reuben Foster, receivers duly
appointed by this Court in a certain suit brought in this court and
now pending therein, wherein William P. Clyde and others are
plaintiffs and the Richmond and Danville Railroad Company and
others are defendants."
These receivers are described in the record as the foreclosure
receivers.
The order last named contained this clause:
"Nothing in this order contained shall be construed to vacate
any of the orders heretofore entered in the case of William P.
Clyde and others, but the court reserves full power to act upon the
masters' reports filed in the said cause, and in said cause to
adjudge and decree upon the rights of creditors ascertaining
[asserting] a claim against the property of the said railroad
company or income thereof, in preference to the mortgage debt
thereof, by orders to be entered in the said suit of William P.
Clyde and others, upon notice to parties, with like effect upon the
mortgaged property and income as if such orders were entered in
this cause."
The Carnegie Company was permitted to intervene in the suit
brought by the Central Trust Company, alleging in its petition that
the rails sold and delivered by it to the Danville Company were
used upon its roadbed for the purpose of maintaining the same in
condition to conduct its traffic thereon, and were necessary for
that purpose. The claimants referred to the fact that they had
previously filed their claim in the Clyde suit,
"which claim is now pending in said cause before the masters,
the demand of your petitioner that the same shall be allowed, as a
claim entitled to equitable priority of payment over the mortgage
debt of the said defendant not having been heard or considered by
said masters."
On the 17th day of February, 1894, the suit instituted by the
Central Trust Company of New York and the one brought by Clyde and
others were consolidated under the name of "
The Central Trust
Company of New York and others v.
Page 176 U. S. 271
The Richmond and Danville Railroad Company and others,
Consolidated Cause." Upon application of the Carnegie Company,
it was made a party defendant in the consolidated cause.
A decree of foreclosure and sale in the consolidated cause was
entered April 13, 1894, and a sale took place June 15, 1894, the
property embraced by the decree being sold as a unit. Charles H.
Coster and Anthony J. Thomas, a purchasing committee, as joint
tenants, purchased the property for the use, benefit, and behoof of
a corporation to be organized pursuant to the terms of an Act of
the General Assembly of Virginia approved February 20, 1894,
entitled "An Act Authorizing the Purchasers of the Richmond and
Danville Railroad, Their Assigns and Successors, to Become and Be a
Corporation." The sale was approved by formal order of court and
confirmed to the purchasing committee, composed of Coster and
Thomas, for the sole use, benefit, and behoof of the Southern
Railway Company created under the laws of Virginia.
The decree of confirmation contained the following clauses:
"And the court accepts the said Southern Railway Company as the
purchaser of all and singular the railroad, property, and
franchises sold under this decree, and holds it as such purchaser
obligated to complete and fully to pay the said bid and comply with
all the orders of the court already entered, and hereafter, from
time to time, to be entered by it obligatory on such purchaser. And
the court further reserves full power from time to time to enter
orders binding upon the said Southern Railway Company as such
purchaser, requiring it to pay into the registry of the court all
such sums as have been or may be ordered by the court for the
payment of any and all receivers' debts or claims adjudged or to be
adjudged as prior in lien or equity to the mortgage herein
foreclosed, or entitled to preference in payment out of the
proceeds of sale."
That order also contained this clause:
"The court reserves full power, notwithstanding such conveyance
and delivery of possession, to retake and resell the property this
day confirmed to such purchaser if it fails or neglects fully to
complete such
Page 176 U. S. 272
purchase and comply with the orders of court in respect to full
compliance therewith, or to pay into court, in accordance with such
decree of sale and orders of court, all sums of money hereafter
ordered by the court to be paid into its registry to discharge any
and all such debts, liens, or claims as it may decree ought to be
paid out of the proceeds of sale in preference to the mortgage
herein foreclosed."
Subsequently, upon a hearing of the exceptions to the masters'
report on the claim of the Carnegie Steel Company, Limited, the
circuit court found that that company furnished to the railroad
company at the dates and in the quantities named in their petition
for claim, steel rails to the aggregate value of $125,067.39, which
the company used and agreed to pay for, and that the interest on
that amount was $29,828.58 -- in all, $154,895.97. It further found
that that sum had never been paid by the railroad company; that
"the earnings of said defendant railroad company, which should
have been used for the payment of current expenses, including
therein this claim, have been used for the benefit of mortgage
creditors in a sum more than sufficient to pay said claim in
full,"
and that,
"prior to May 1, 1888, bonds of the Richmond and Danville
Railroad Company known as consolidated bonds were issued to the
amount of $1,621,000, and that since that date, such bonds have
been issued to the amount of $2,906,000."
And it was adjudged that the claim, with interest thereon from
the time when the respective items thereof became due and payable
by the Danville Company, was entitled to priority of payment out of
the funds resulting from the sale of the mortgaged property, over
the bonds secured by the mortgage foreclosed by the decree
heretofore passed in this cause, and was also entitled, by reason
also of the statutes of Virginia,
"to priority of payment out of the fund resulting from the sale
of the mortgaged property over such of the bonds secured by the
mortgage foreclosed by the decree heretofore passed in this cause
as were issued after May 1, 1888, being $2,906,000 in amount."
It was further ordered that
"the purchaser at the sale heretofore made, or his assigns, do
forthwith pay to the Carnegie Steel Company, Limited, said sum of
$154,895.97 in
Page 176 U. S. 273
compliance with the terms of the decree of sale heretofore
passed, whereby the purchaser at such sale or his assigns was
required to pay off and satisfy all claims filed in this cause
which this Court should adjudge prior to the mortgage by said
decree foreclosed."
The Southern Railway Company prosecuted an appeal from that
order to the circuit court of appeals, and the action of the
circuit court was approved. 76 F. 492. The case is in this Court
upon certiorari, sued out by the railway company.
MR. JUSTICE HARLAN, after stating the facts as above, delivered
the opinion of the Court.
It appears from the above statement that the property in the
hands of the receivers in the Clyde or insolvency suit was
surrendered to the receivers in the foreclosure suit under an order
that expressly reserved power in the court to adjudge and decree in
the Clyde suit upon the rights of creditors asserting claims
against the property of the railroad company or its income in
preference to mortgage debts. Besides, the decree of sale provided
that the purchaser or purchasers, or his or their assigns, under
any decretal sale should, as a part of the consideration, in
addition to any sum bid, take the property upon the express
condition that he or they would pay and satisfy (among other
specified claims) all claims theretofore
"filed in this case or in either of the causes, consolidated
herein, but only when said court shall allow such claims and
adjudge the same to be prior in lien or superior in equity to the
mortgage foreclosed in this suit, and in accordance with the order
or orders of the court allowing such claims and adjudging with
respect thereto."
And the right was distinctly
Page 176 U. S. 274
reserved to retake and resell the property in case the purchaser
or purchasers, or his or their assigns, failed or neglected to
comply with the order of court in respect of the payment of such
prior liens. These conditions were repeated in the order confirming
the sale. So that the right of the Carnegie Company to have its
claims determined upon their merits is not at all affected by the
sale of the property held by the receivers in the consolidated
cause, or by the fact of its transfer to the Southern Railway
Company. And we add that the above reservation in the orders and
decree of the Circuit Court left it open for the Southern Railway
Company to contest upon their merits any claims allowed after its
purchase under the decree of sale.
The respective rights of the mortgagees of a railroad company
and of parties having claims against it at the time its property
passed into the hands of receivers have been frequently the subject
of consideration by this Court. But as counsel differ as to the
scope and effect of former decisions, it is necessary to examine
them and ascertain whether those decisions embrace the case now
before the court.
The leading case is
Fosdick v. Schall, 99 U. S.
235,
99 U. S.
252-253, which related to a claim against a railroad
company for rent of cars. In that case, Chief Justice Waite
delivered the unanimous judgment of the Court. After observing that
the business of all railroad companies was done to a greater or
less extent on credit, and that this credit was longer or shorter
as the necessities of the case required, he said:
"The income 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 upon the income. If, for the
convenience of the moment, something is taken from what may not
improperly be called the current debt fund and put into that which
belongs to the mortgage creditors, it certainly is not inequitable
for the court, when asked by the
Page 176 U. S. 275
mortgagees to take possession of the future income and hold it
for their benefit, to require, as a condition of such an order,
that what is due from the earnings to the current debt shall be
paid by the court from the future current receipts before anything
derived from that source goes to the mortgagees. In this way, the
court will only do what, if a receiver should not be appointed, the
company ought itself to do. For even though the mortgage may in
terms give a lien upon the profits and income, until possession of
the mortgaged premises is actually taken or something equivalent
done, the whole earnings belong to the company and are subject to
its control."
The Court further said:
"The mortgagee has his strict rights which he may enforce in the
ordinary way. If he asks no favors, he need grant none. But if he
calls upon a court of chancery to put forth its extraordinary
powers and grant him purely equitable relief, he may with propriety
be required to submit to the operation of a rule which always
applies in such cases, and do equity in order to get equity. The
appointment of a receiver is not a matter of strict right. Such an
application always calls for the exercise of judicial discretion,
and the chancellor should so mould his order that, while favoring
one, injustice is not done to another. If this cannot be
accomplished, the application should ordinarily be denied. We think
also that if no such order is made when the receiver is appointed
and it appears in the progress of the cause that bonded interest
has been paid, additional equipment provided, or lasting and
valuable improvements made out of earnings which ought in equity to
have been employed to keep down debts for labor, supplies, and the
like, it is within the power of the court to use the income from
the receivership to discharge obligations which, but for the
diversion of funds, "
brk:
would have been paid in the ordinary course of business. This
not because the creditors to whom such debts are due have in law a
lien upon the mortgaged property or the income, but because, in a
sense, the officers of the company are trustees of the earnings for
the benefit of the different classes of creditors and the
stockholders, and if they give to one class of creditors that which
properly belongs to another, the
Page 176 U. S. 276
court may, upon an adjustment of the accounts, so use the income
which comes into its own hands as, if practicable, to restore the
parties to their original equitable rights. While ordinarily this
power is confined to the appropriation of the income of the
receivership and the proceeds of moneyed assets that have been
taken from the company, cases may arise where equity will require
the use of the proceeds of the sale of the mortgaged property in
the same way. . . . No fixed and inflexible rule can be laid down
for the government of the courts in all cases. Each case will
necessarily have its own peculiarities, which must to a greater or
less extent influence the chancellor when he comes to act. The
power rests upon the fact that in the administration of the affairs
of the company the mortgage creditors have got possession of that
which in equity belonged to the whole or a part of the general
creditors. Whatever is done, therefore, must be with a view to a
restoration by the mortgage creditors of that which they have thus
inequitably obtained. It follows that if there has been in reality
no diversion, there can be no restoration, and that the amount of
restoration should be made to depend upon the amount of the
diversion. If, in the exercise of this power, errors are committed,
they, like others, are open to correction on appeal. All depends
upon a proper application of well settled rules of equity
jurisprudence to the facts of the case, as established by the
evidence.
In
Hale v. Frost, 99 U. S. 389, it
appeared that a receiver was appointed in a suit brought by
trustees to foreclose mortgages executed by a railroad company. He
was appointed May 19, 1875, at which time the company owed
employees for back wages and was indebted for current supplies. To
the Union Car Spring Manufacturing Company it was indebted for
springs and spirals furnished in March and April before the
appointment of the receiver, and which he continued to use. It was
also indebted to Hale, Ayer & Co. for supplies to the machinery
department and for materials for construction purposes, and on the
13th day of February, 1873, a given amount was due them, as
evidenced by the notes of the railroad company falling due on that
day. The judges who
Page 176 U. S. 277
heard the case in the court of original jurisdiction were
divided in opinion on the following points made by intervening
creditors: 1. That the railway mortgage was a prior lien only upon
the net earnings of the road, after the payment of all the
operating expenses, while the road was in the possession of the
company. 2. That after the default in the payment of the interest
November 1, 1873, the fact that the mortgagees funded their coupons
and left the company in possession of the road constituted the
company their agent and trustee in equity, and they were estopped
from objecting to the payment from the earnings of the road of all
legitimate debts contracted by the company for operating expenses.
3. That the net earnings of the road, while in the possession of
the court and operated by its receiver, were not necessarily and
exclusively the property of the mortgagees, but were subject to the
disposal of the chancellor in the payment of claims which had
superior equities, if such should be found to exist, and that the
intervening petitioners' claims had superior equities to those of
the mortgagees. The petitions were dismissed, and the interveners
appealed. This Court, speaking by Chief Justice Waite, said:
"The first question certified in this case is answered in the
affirmative, upon the authority of
Fosdick v. Schall. The
third question is answered in the same way upon the same authority.
The Union Car-Spring Manufacturing Company is entitled to payment
in full, and Hale, Ayer & Co. to payment of so much of their
claim only as is for supplies to the machinery department. There is
nothing in the case to show any special equities in their favor in
respect to that part of their account which is for material for
construction purposes. An answer to the second question is
unnecessary."
In
Burnham v. Bowen, 111 U. S. 776,
111 U. S.
780-783, it appeared that the trustees of a mortgage
covering all the property of a railroad company and all the
revenues and income thereof, brought suit to foreclose the
mortgage, 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. When the receiver took possession the
railroad
Page 176 U. S. 278
company was indebted for coal used on locomotives -- a debt
contracted by the company in the ordinary course of a continuing
business, and which would have been paid out of current earnings at
the time agreed on if the company had remained in possession. The
debt due the coal company was evidenced by the acceptances of the
railroad company, which were for different amounts, maturing a
month apart, thus implying, as this Court said, monthly settlements
of monthly accounts, with a somewhat extended credit to meet the
business requirements of the railroad company. A decree was entered
finding the amount due to Bowen, the holder of the acceptances, and
declaring that the mortgaged property in the hands of the trustees
under the decree of foreclosure was equitably bound for the payment
thereof.
Chief Justice Waite, delivering the unanimous judgment of this
Court, said:
"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
Page 176 U. S. 279
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 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 was contended in that case that no part of the income, prior
to the receiver's appointment, was used to pay mortgage interest or
to put permanent improvements on the property, or to increase the
equipment, and therefore 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. Touching
that contention, this Court said:
"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,
Page 176 U. S. 280
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 a 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 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."
The opinion in that case thus concluded:
"We do not now hold, any more than we did in
Fosdick v.
Schall or
Huidekoper v. Hinckley Locomotive Works,
99 U. S.
258,
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. "
Page 176 U. S. 281
In
Union Trust Co. v. Morrison, 125 U.
S. 591,
125 U. S. 609,
125 U. S. 612,
the contest was between the mortgagees and Morrison, who had become
surety in a bond given by an insolvent railroad company which was
harassed by suits in order to prevent a levy by a sheriff upon its
rolling stock. Subsequently a suit was brought to foreclose a
mortgage upon the railroad. The giving of the bond undoubtedly
protected the company's property from seizure and enabled it to
remain a going concern, and saved it to the mortgagees. This Court,
speaking by Mr. Justice Bradley, said:
"Even if it [the rolling stock] would have been subject to the
mortgage, when taken on execution, nevertheless it could have been
taken,
* and this would necessarily
have disturbed, and perhaps interrupted, the operations of the
railroad, by separating the property seized from the corpus of the
estate. The trustees of the mortgage might have prevented such a
catastrophe, it is true, by filing a bill of foreclosure and for an
injunction and receiver, but they did not choose to take this
course until nearly three years afterwards; on the contrary, they
allowed the railroad company to continue to use the property, and
to take care of it for them, and stood by and saw Morrison (who had
no interest in the matter) put his hands into the fire and rescue
the rolling stock of which they were to receive the benefit -- both
directly, by receiving the property itself without contest or
controversy, and indirectly, by keeping up the railroad as a going
concern. Morrison's money, or the fruits of it, has gone into their
pockets. And, in this regard, we make no distinction between the
mortgagees, the bondholders, whom they represented, the nominal
purchasers, Horsey and Canda, or the present company. They were all
one and the same in interest. If the property became justly
affected by the equity of the petitioner's claim, it remains so
affected in the hands of the present company."
Referring to prior cases, and disclaiming
Page 176 U. S. 282
any purpose to modify the rule charging operating expenses upon
current earnings, the Court said:
"The present claim is of a different character, based upon a
bona fide effort made by the intervener to preserve the
fund itself from waste and spoliation after the mortgage was in
arrears and the right to reduce it to possession had accrued. But
even here, as we have seen, if the claimant could pursue only the
earnings, it is shown that they have been appropriated to the
purchase of property which has been added to the fund."
In
St. Louis Alton &c. Railroad v. Cleveland, Columbus
&c. Railway, 125 U. S. 658,
125 U. S. 673,
the Court, speaking by Mr. Justice Matthews, after stating that
ordinarily the unsecured debts of an insolvent railroad company
cannot 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, said:
"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."
"The rule," the Court said,
"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 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."
In
Kneeland v. American Loan & Trust Co.,
136 U. S. 89,
136 U. S. 97,
this Court said:
"The appointment of a receiver vests in the court no absolute
control over the property, and no general authority to displace
vested contract liens. Because in a few specified and limited cases
this Court has declared that unsecured claims were entitled to
priority over mortgage debts, an idea seems to have obtained that a
court appointing a receiver acquires power to give such preference
to any general and
Page 176 U. S. 283
unsecured claims. It has been assumed that a court appointing a
receiver could rightfully burden the mortgaged property for the
payment of any unsecured indebtedness. Indeed, we are advised that
some courts have made the appointment of a receiver conditional
upon the payment of all unsecured indebtedness, in preference to
the mortgage liens sought to be enforced. Can anything be conceived
which more thoroughly destroys the sacredness of contract
obligations? One holding a mortgage debt upon a railroad has the
same right to demand and expect of the court respect for his vested
and contracted priority as a holder of a mortgage on a farm or lot.
So when a court appoints a receiver of railroad property, it has no
right to make that receivership conditional on the payment of other
than those few unsecured claims which, by the rulings of this
Court, have been declared to have an equitable priority. No one is
bound to sell to a railroad company or to work for it, and whoever
has dealings with a company whose property is mortgaged must be
assumed to have dealt with it on the faith of its personal
responsibility, and not in expectation of subsequently displacing
the priority of the mortgage liens."
Again:
"It is the exception, and not the rule, that such priority of
liens can be displaced. We emphasize this fact of the sacredness of
contract liens for the reason that there seems to be growing an
idea that the chancellor, in the exercise of his equitable powers,
has unlimited discretion in this matter of the displacement of
vested liens."
These principles were reaffirmed in
Thomas v. Western Car
Co., 149 U. S. 95,
149 U. S. 110,
in which it was held that the car company there seeking a
preference over mortgage creditors had contracted upon the
responsibility of the railroad company, and not in reliance upon
the interposition of a court of equity; consequently its claim to a
preference was denied.
In
Virginia & Alabama Coal Co. v. Central Railroad &
Banking Co., 170 U. S. 355,
170 U. S. 365,
170 U. S. 368,
the Court, referring to the decision in
Burnham v. Bowen,
said:
"It was thus settled that where coal is purchased by a railroad
company for use in operating lines of railway owned and controlled
by it in
Page 176 U. S. 284
order that they may be continued as a going concern, and where
it was the expectation of the parties that the coal was to be paid
for out of current earnings, the indebtedness, as between the party
furnishing the materials and supplies and the holders of bonds
secured by a mortgage upon the property, is a charge in equity on
the continuing income, as well that which may come into the hands
of a court after a receiver has been appointed as that, before. It
is immaterial in such case, in determining the right to be
compensated out of the surplus earnings of the receivership,
whether or not during the operation of the railroad by the company
there had been a diversion of income for the benefit of the
mortgage bondholders, either in payment of interest on mortgage
bonds or expenditures for permanent improvements upon the property.
Nor is the equity of a current supply claimant in subsequent income
arising from the operation of a railroad under the direction of the
court affected by the fact that, while the company is operating its
road, its income is misappropriated and diverted to purposes which
do not inure to the benefit of the mortgage bondholders, and are
foreign to the beneficial maintenance, preservation, and
improvement of the property."
In the opinion in that case, the Court observed that it did not
intend to detract from the force of the intimations contained in
Kneeland v. American Loan & Trust Co. and
Thomas
v. Western Car. Co., above cited,
"as to the necessity of a court of equity confining itself
within very restricted limits in the application of the doctrine
that, in certain cases, a court having a road or fund under its
control may be justified in awarding priority over the claims of
mortgage bondholders to unsecured claims originating prior to a
receivership."
And it was further said:
"In neither the
Kneeland nor the
Thomas case
was there any intention to question the prior decisions of the
court which allowed priority to claims based upon the furnishing of
essential and necessary current supplies, not sold upon mere
personal credit, against the surplus income arising during the
operation of the road under the direction of a court of
equity."
It is apparent from an examination of the above cases that
Page 176 U. S. 285
the decision in each one depended upon its special facts. This
Court has uniformly refrained from laying down any rule as
absolutely controlling in every case involving the right of
unsecured creditors of a corporation, whose property is in the
hands of a receiver, to have their demands paid out of net earnings
in preference to mortgage creditors. But it may be safely affirmed,
upon the authority of former decisions, that a railroad mortgagee,
when accepting his security, impliedly agrees that the current
debts of a railroad company contracted in the ordinary course of
its business shall be paid out of current receipts before he has
any claim upon such income; that, within this rule, a debt not
contracted upon the personal credit of the company, but to keep the
railroad itself in condition to be used with reasonable safety for
the transportation of persons and property, and with the
expectation of the parties that it was to be met out of the current
receipts of the company, may be treated as a current debt; that
whether the debt was contracted upon the personal credit of the
company, without any reference to its receipts, is to be determined
in each case by the amount of the debt, the time and terms of
payment, and all other circumstances attending the transaction, and
that, when 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 any funds thus
improperly diverted from their primary use. The doctrine announced
in
Burnham v. Bowen -- in which case the decisions in
prior cases were affirmed -- is thus expressed in the recent case
of
Virginia & Alabama Coal Co. v. Central Railroad
Company, above cited:
"The dominant feature of the doctrine as applied in
Burnham
v. Bowen is that where expenditures have been made which were
essentially necessary to enable the road to be operated as a
continuing business, and it was the expectation of the creditors
that the indebtedness created would be paid out of the current
earnings of the company, a superior equity arises in favor of the
materialman as against the mortgage bonds in the income arising
both before and after the appointment of a receiver from the
operation of the
Page 176 U. S. 286
property. The equity thus held to arise when a purchase of
necessary current supplies is made by the owning company is not in
any wise influenced by the fact that the company itself is the
purchaser of the supplies, but is solely dependent upon the fact
that the supplies are sold and purchased for use, and that they are
used in the operation of the road, that they are essential for such
operation, and that the sale was not made simply upon personal
credit, but upon the tacit or express understanding that the
current earnings would be appropriated for the payment of the
debt."
Can the decree below be sustained consistently with these
principles? Are the debts due the Carnegie Company of the class
designated in the adjudged cases as current debts contracted not on
the personal credit of the railroad company, but in the ordinary
course of its business, and to be met out of current receipts? As
already said, whether the parties, seller and buyer, had in view
only the personal credit of the latter is to be determined in each
case by its special facts, including the amount of the debt and the
terms of payment.
All the rails furnished by the Carnegie Company were not
supplied under one contract -- a circumstance not to be ignored
when determining whether the debts were of the kind that would
ordinarily be met out of current receipts. The first contract
between the Carnegie Company and the Danville Company was made June
10, 1891 -- within within less than twelve months before the
appointment of receivers in the Clyde suit. It called for the
delivery by the Carnegie Company, during the month of July, 1891,
of only 2,500 gross tons of rails for which the railroad company
was to pay thirty dollars per gross ton, in its notes at four
months from date of shipment
without interest, with
privilege of one renewal for three months with interest at the rate
of five percent per annum and a second renewal for three months
with interest at the rate of six percent per annum. The railroad
company reserved the option to increase by 200 or 300 the number of
tons to be delivered, making the total delivery 2,700 or 2,800
tons. That option was exercised. By another arrangement between
Page 176 U. S. 287
the parties entered into July 21, 1891, the contract was further
extended to cover 1,656 tons of rails at the same price, terms, and
delivery. Subsequently, by agreement of October 2, 1891, a
provision was made for the delivery of 200 additional tons at the
price of $26 per ton. The delivery of the rails was in varying
amounts and at different times between July 25, 1891, and October
10, 1891. The whole quantity delivered was 4,203 350/2240 tons,
worth $125,067.39. Notes were given by the railroad company, and
they were renewed at their respective maturities. Those last given,
and which were unpaid at the time of the institution of the Clyde
or insolvency suit, were each payable at three months, except the
last one, which was at four months. They were of the following
dates and amounts: March 21, 1892, $38,251.77; March 24, 1892,
$35,499.38; April 4, 1892, $12,786.16; May 16, 1892, $5,355.09;
June 7, 1892, $33,174.99. The first note was due June 21-24, 1892
(six days only after the appointment of receivers in the Clyde
suit), and the last October 7-10, 1892.
The rails so received from the Carnegie Company were used by the
Danville Company on the following roads in its possession and under
its control: 1108.5 tons 56lb, $33,174.99, on the Northeastern
Railroad of Georgia; 1270 tons 731b, $37,713.75, on the Virginia
Midland Railroad; 1793.5 tons 70lb, $53,258.69, on the Richmond and
Danville Railroad; 31.2 tons 70lb, $920.56, on the Georgia Pacific
Railroad. This use of the rails is shown by the report of special
masters, and to that report on this point no exceptions were filed
by either party.
What was the condition of the roads owned and controlled by the
Danville Company at the time the rails were purchased and used? It
was in the power of the railroad company and its receivers, who had
possession of the books of the company, to have furnished evidence
on this point that would have removed all possible doubt. But there
is enough in the record to show that the rails purchased from the
Carnegie Company were needed in order that the roads in question
might be kept by the railroad company in that condition of safety
which its duty to the public and to the mortgage bondholders
required. In August, 1892,
immediately after the receivers took
possession
Page 176 U. S. 288
of the railroads constituting the Danville system, they
reported to the court that the financial difficulties of the
Danville Company during the previous two years had
"prevented the operating officers from being able to expend the
proper amount
for new rails and upon the roadbed and structures
to keep the railroad in the condition in which it should be
maintained, and it will be necessary for the receivers, during
the summer and autumn, to make a much larger expenditure than they
would for ordinary maintenance."
Here is a direct admission by the receivers that, during the two
years immediately preceding their appointment, the railroad company
had not expended for new rails and upon the roadbed and structures
the amount necessary to keep its road in proper condition. There is
no evidence in the record which even tends to show that the
statements of the receivers on this point were not strictly
accurate. But this purchase of new rails proved to be inadequate,
for on the 27th of January, 1894, the foreclosure receivers
represented to the court, by petition, that
"for
the proper and
economical operation of
the lines of railroad of which they are receivers, and
for the
safety of passengers and property transported over such roads,
as required by the order of this court appointing such receivers,
2,000 tons of new steel rails are
an absolute
necessity,"
and that they
"had negotiated with and purchased from the Carnegie Steel
Company, Limited, subject to the approval of the court, that
quantity of rails at a cost of $24 per ton."
The court made an order in accordance with that petition. Again,
on the 13th day of April, 1894, the court -- all parties to the
foreclosure suit consenting thereto, including the bondholders'
committee -- made an order authorizing the receivers to purchase
2,500 tons of new steel rails in order "
to properly operate the
railroads" in their charge "
and for the safety of persons
and property transported."
It is apparent that the purchases of new steel rails while the
railroads were in possession of receivers were made in the ordinary
course of business and were properly chargeable upon and payable
out of current receipts in preference to the claims of mortgage
creditors. In every substantial sense, the
Page 176 U. S. 289
expenses thus incurred were operating expenses. They were
incurred in the interest of mortgage creditors, the value of whose
securities depended upon the unity of the Danville system being
preserved and the interests of all concerned not allowed to go to
ruin. Why should a different rule be applied to the contracts made
with the Carnegie Company
shortly before the appointment of
receivers in the Clyde suit, the original contract being for
only 2,500 tons, and the last one for only 1,656 tons? Is it to be
said that the contract for 2,000 tons of steel rails and the
contract for 2,500 tons, made by the receivers in the foreclosure
suit, created debts of a preferential character, while contracts
made by the railroad company of exactly the same kind shortly
before the appointment of receivers for 2,500 and 1,656 tons of
steel rails could not under any circumstances become a preferential
debt chargeable upon current receipts? Surely the quantity of rails
purchased from the Carnegie Company and delivered in 1891 was
insignificant in view of the interests involved and the extensive
mileage of the Danville system, and was by no means so large as to
suggest that they were to be used in constructing new and
additional road, and not to keep existing roads in proper condition
for use. Every railroad company must have on hand a limited
quantity of rails in order to keep every part of its line in proper
and safe condition. It is evident that the Carnegie rails purchased
shortly before the receivers in the Clyde suit were appointed --
the the rails here in question -- were obtained for the same reason
that induced the subsequent purchases by the receivers. No one will
say that the use of these rails did not add directly to the value
of the securities of mortgage creditors. Within the reason of the
rule adverted to, the debts contracted with the Carnegie Company
were as much current debts in the ordinary course of the business
of the railroad company as were the debts contracted by the
receivers under the orders of court, when they purchased new rails
to put the road in safe condition, or when they purchased at one
time four passenger locomotives, and at another time eight
passenger and freight locomotives, the cost of which was charged
upon the income in their hands. Is it to be said
Page 176 U. S. 290
that such expenses incurred by the receivers were preferential
debts, but that debts incurred by the railroad company shortly
prior to the receivership for rails needed to keep its road in safe
condition for use are not of that class?
We next inquire whether it was not at the time the expectation
of both parties, vendor and vendee, that the rails delivered by the
Carnegie Company between July 25, 1891, and October 10, 1891,
should be paid for out of the current earnings of the railroad
company? The attendant circumstances require an affirmative answer
to this question, although the parties did not in express words
declare that the debts due contracted with the Carnegie Company
were to be charged upon the current earnings of the railroad
company. The quantity of rails was not so large as to preclude the
expectation that they could be paid for out of the current earnings
of the railroad company. As already said, it was a very small
quantity for purposes of ordinary or necessary repairs, and there
is nothing in the record to show that the Carnegie Company relied
merely or exclusively on the personal credit of the railroad
company. The renewal notes executed by the railroad company were
all within the
three months
immediately
preceding the appointment of the receivers. The short credit
given strongly indicates, and the fair inference from the record
is, that the parties contemplated that the rails were to be paid
for out of the current earnings of the railroad. The taking of
notes does not indicate the contrary, but only shows that the
vendor company preferred to have its debt evidenced by commercial
paper which it could use, rather than to stand upon open account.
In
Burnham v. Bowen, it was said:
"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 equities of the creditor furnishing that which protected and
preserved
Page 176 U. S. 291
the mortgage security and materially increased its value are
none the less because the original debt was evidenced by the notes
of the company, taken for its convenience and renewed for its
accommodation.
It may be said that a part of the rails furnished by the
Carnegie Company were not used on the Danville railroad, although
used on roads belonging to the Danville system. But that is not a
controlling circumstance. The contracts were made with the Danville
Company, and, as between the contracting parties, the debts so
incurred were, under the circumstances stated, current debts
chargeable upon the current receipts of the railroad company that
purchased the rails. The rights of the Carnegie Company are none
the less because the Danville Company chose, after obtaining the
rails, to use a part of them on roads under its control and in its
possession, and whose preservation in proper condition was vital to
its successful operation. The scheme of reorganization was in the
interest of the stockholders and mortgage creditors of the roads
constituting the Danville system, and chiefly of the bondholders
represented by the Central Trust Company, the trustee in the
consolidated gold mortgage. That company, as we shall presently
show, stood by and assented to -- indeed, approved -- the
application for the benefit of the bondholders represented by it of
funds which should have been applied in payment of current debts
contracted in the interest of mortgage creditors before the
appointment of receivers in the Clyde suit. Suppose the court had
directed the receivers in the Clyde suit, before turning over the
property to the receivers in the foreclosure suit, to pay the
claims of the Carnegie Company; is it possible that the mortgage
creditors would have been heard to object to such an order?
Certainly not, if it appeared, as it does satisfactorily appear in
the present case, that the Carnegie debts were incurred in the
ordinary course of business for the purpose of keeping the railroad
in safe condition for use by the public. If the Carnegie claims
were preferential debts when the control of the property passed
from the railroad company to the receivers in the insolvency or
Clyde suit, the latter were bound in equity to
Page 176 U. S. 292
do what the railroad company would have been required to do if
it had retained control of the property.
If the parties to the contract contemplated that the notes given
for the rails should be paid for out of the current earnings of the
railroad, and if the Carnegie Company lost no equity merely by
renewing the notes, it follows, under the settled doctrine of this
Court that the mortgagees could not have objected to the payment of
the renewal notes out of any net earnings in the hands of
receivers, although the contract for the rails was a few months
back of the six months immediately preceding their appointment.
Each case, as already observed, must depend largely upon its
special facts. In some cases, the courts, in their administration
of railroad property by receivers, have refused to give priority to
unsecured claims that did not accrue within six months immediately
preceding the appointment of receivers. Such a rule will do full
justice in most cases to creditors who are entitled to look to
current receipts for the payment of current debts. But no absolute
rule on the subject has been prescribed by statute or by judicial
decisions. A claim accruing back of the six months immediately
preceding the appointment of a receiver may, under the
circumstances of particular cases, be accorded the same priority in
the distribution of earnings that belongs to like claims arising
within that period. Touching this question of time and the
principles upon which the equitable rights of creditors in such
cases as this rest, MR. JUSTICE BREWER said, in
Blair v. St.
Louis &c. Railway Co., 22 F. 471, 474:
"The idea which underlies them I take to be this: that the
management of a large business, like that of a railroad company,
cannot be conducted on a cash basis. Temporary credit, in the
nature of things, is indispensable. Its employees cannot be paid
every month. It cannot settle with other roads its traffic balances
at the close of every day. Time to adjust and settle these various
matters is indispensable. Because, in the nature of things, this is
so, such temporary credits must be taken as assented to by the
mortgagees. . . . In this view, such temporary credits accruing
prior to the appointment of the receiver must be recognized by the
mortgagees
Page 176 U. S. 293
and such claims preferred. Now for what time prior to the
appointment of a receiver may these credits be sustained? There is
no arbitrary time prescribed, and it should be only such reasonable
time as, in the nature of things and in the ordinary course of
business, would be sufficient to have such claims settled and paid.
Six months is the longest time I have noticed as yet given.
Ordinarily, I think that is ample. Perhaps, in some large concerns,
with extensive lines of road and a complicated business, a longer
time might be necessary."
What was done with the earnings of the property that originally
came to the hands of the receivers, as well as with the earnings
during the receivership under the Clyde bill and also during the
receivership in the foreclosure suit instituted by the Central
Trust Company? As to these matters, there is no room for dispute.
Assuming, in view of what has been said, that the claims of the
Carnegie Company were current debts chargeable upon current
earnings of the railroad property, even while in the hands of the
receivers, and therefore to be preferred to claims of mortgage
creditors, the next inquiry is whether the current receipts were
applied during the receiverships for the benefit of the
bondholders, or otherwise, when they should have been applied to
the payment of current or preferential debts, including the debts
due to the Carnegie Company.
During the insolvency or Clyde receivership, from June 17, 1892,
to July 31, 1893, the net earnings were $3,297,792.31. Among the
items of expenditure during the same period were the following:
construction, $232,134.34, of which $19,715.05 was for
construction on the Danville road; equipment, $81,390.32,
of which $74,733.28 was for equipment on the Danville road;
interest, rentals, and dividends, $3,249,481.89, of which
$396,522.14 was
for the Danville road, $709,324 for the
Virginia Midland, $20,265 for the North Eastern, and $232,127 for
the Georgia Pacific road, the last four roads being those on which,
according to the special master's report, the Carnegie rails were
used; sinking fund, Richmond and Danville road, five percent
equipment mortgage, $67,205, and car trust payments, $209,500.
Page 176 U. S. 294
Between August 1, 1893, and December 31, 1893, out of the net
earnings of the Danville system, excluding certain lines, the
receivers paid among other sums the following: construction
on
Danville road, $9,232.61; equipment on same road, $6,791.35;
interest, rentals, and dividends, $626,735.85, which included
$48,082.90 for the Danville road, Virginia Midland, $199,664.50,
and $87.50 for the North Eastern Railroad; sinking fund, Danville
Company, equipment mortgage, $37,790; car trust payments,
$51,160.
The above figures are found in the statement of the result of
the operations of the Danville system for the periods named.
Looking at the cash statement of the receipts and disbursements
of the Richmond & Danville Railroad alone, we find that from
June 16, 1892, to July 31, 1893, the receipts were $15,432,055.46.
In this sum were included $480,427.91 cash received from the
Danville Company when the Clyde or insolvency receivers were
appointed and $671,363.40 collected on accounts turned over to
those receivers by the railroad company. The disbursements during
the above period were $15,290,730.27, leaving in the hands of the
receivers on July 31, 1893, $141,325.19 in cash, which was turned
over to the foreclosure receivers. The disbursements included among
other items the following: interest and rentals, $3,249,481.89; car
trust payments and sinking funds, $486,368.16.
The account of disbursements for the Danville road from August
1, 1893, to November 30, 1893, shows, among other things, the
payment of interest and rentals, $591,457.42; car trust payments
and sinking fund, $88,950.
The total floating debt of the Richmond and Danville Railroad
remaining unpaid was $318,324.71, of which $22,186.53 represented a
claim of the Western Union Telegraph Company in part for labor and
supplies and in part for construction of telegraph line, and
$90,000 represented a claim of the Pullman Palace Car for mileage
of cars. Of the balance, $125,067.39 represented the claims of the
Carnegie Company, and $80,317.98 represented all other claims.
These figures show that both during the receivership in the
Page 176 U. S. 295
Clyde suit and the receivership in the foreclosure suit, immense
sums were expended in paying interest, sinking fund, and car trust
debts, and for construction and equipment, which were all for the
benefit of mortgage creditors and which, to the extent necessary,
should have been applied in payment of preferential claims,
including those of the Carnegie Company. It is a clear case of a
diversion of income from the payment of current debts in the
interest of mortgage creditors. Judge Simonton well said:
"There can be no question that the steel rails furnished by the
Carnegie Steel Company come within the class of supplies necessary
to keep the railroad company a going concern. And the evidence
establishes the fact that, after incurring the debt, the railroad
company was in the receipt of large earnings, which were applied to
permanent improvements, rentals, and interest on the mortgage debt;
that the receivers who, under the Clyde bill, took possession of
the property, earned large income which was applied in the same
way, leaving this debt unpaid, and that, when these receivers were
discharged, they showed in their accounts a cash surplus, which was
duly paid over to their successors under the Central Trust Company
bill."
Looking at the case in the light of the principle that a
mortgagee cannot require from the mortgagor an account of the
earnings, tolls, and income until he has made demand therefor or
for a surrender of possession under the provisions of the mortgage,
Sage v. Memphis & Little Rock Railroad, 125 U.
S. 361,
125 U. S. 378;
Fosdick v. Schall, 99 U. S. 235,
99 U. S. 253,
the circuit court of appeals also said:
"When, therefore, the receivers appointed at the instance of
stockholders and creditors took possession, they enjoyed the same
right to the earnings and income which the railroad company
enjoyed, and rightfully received them. As the railroad company
would have been bound to use this income in the payment of the
current expenses for labor and supplies, the receivers should have
done so also. But instead of this, the receivers diverted the
earnings, income, and funds in their hands toward the betterment of
the property, permanent improvements and additions to it, and
payment of interest. And this was natural. They were appointed
to
Page 176 U. S. 296
take possession of the property and to conserve it until a plan
of reorganization could be adopted and perfected. To facilitate
this plan, the property must be kept up. To this end the funds
coming from earnings were used. When the purpose of the first
receivership was accomplished, the mortgage creditors came in and
reaped the benefit. Surely those creditors whose claims were
neglected, and from whom the earnings were diverted, have the right
to ask and receive at the hands of the court the recognition and
preservation of their claims."
76 F. 498. Judge Morris filed a concurring opinion, and took the
same general view of the case as that expressed by Judge Simonton
for the court. He said that the case was that of
"a supply creditor seeking to be paid out of the earnings which
came to the receivers after his debt matured and which were
diverted by them, without opposition from the mortgagee, to
expenditures which directly resulted in preserving the mortgaged
property, which earnings, if the receivers had not been appointed,
there is no ground for supposing would not have been applied by the
company to the payment of the supply creditor's debt."
76 F. 501.
We must not be understood as saying that a general unsecured
creditor of an insolvent railroad corporation in the hands of a
receiver is entitled to priority over mortgage creditors in the
distribution of net earnings simply because that which he furnished
to the company prior to the appointment of the receiver was for the
preservation of the property and for the benefit of the mortgage
securities. That, no doubt, is an important element in the matter.
Before, however, such a creditor is accorded a preference over
mortgage creditors in the distribution of net earnings in the hands
of a receiver of a railroad company, it should reasonably appear
from all the circumstances, including the amount involved and the
terms of payment, that the debt was one fairly to be regarded as
part of the operating expenses of the railroad incurred in the
ordinary course of business and to be met out of current
receipts.
Passing by as unnecessary to be determined some of the questions
discussed by counsel, our conclusion is that as current earnings
which should have been applied in meeting current
Page 176 U. S. 297
expenses or liabilities, including the debt due the Carnegie
Company, were diverted for the benefit of mortgage creditors, it
was the duty of the court to see that that company was reinstated
in its claim of priority over the mortgage creditors in the
distribution or application of the net earnings of the property.
That duty was properly performed by the circuit court, and the
decree of the circuit court of appeals affirming the judgment of
the Circuit Court is
Affirmed.
MR. JUSTICE Brewer, not having heard the argument in this case,
did not participate in the decision.
* The Constitution of Illinois of 1870, in which state the case
arose, declared, Article XI, ยง10, that
"the rolling stock and other movable property belonging to any
railroad company or corporation in this state shall be considered
personal property, and shall be liable to execution and sale in the
same manner as the personal property of individuals."
MR. JUSTICE WHITE dissenting:
As I comprehend the record, the rails for which preferential
payment is now allowed did not serve the purpose of ordinary repair
and maintenance of the tracks in which they were laid. Moreover, my
understanding of the proof is that it obviously shows there was no
surplus revenue at any time legally applicable to the claim now
allowed, and hence that no such revenue was diverted to the benefit
of the foreclosing mortgage creditors during either of the
receiverships by way of betterments or otherwise. Moreover, I think
the proof is clear that, conceding every possible expense which can
be claimed to have been a betterment or in any wise to have inured
to the benefit of the foreclosing mortgage creditors, nevertheless
as such mortgage creditors have contributed to the payment of the
general creditors, by the assumption of receivers' certificates and
cash contributions, a sum largely in excess of the amount of such
payments for assumed betterments, etc., the mortgage creditors are
entitled to credit for their advances, and therefore there would be
a large balance in their favor. In effect, to state the presumed
betterments and charge them against the foreclosing mortgage
creditors, without referring to or taking into account their
contributions, is to charge them for betterments for which they
have already paid.
St. Louis, Alton &c. Railroad v.
Cleveland, Columbus &c. Railway, 125 U.
S. 658.
I therefore dissent.
MR JUSTICE BREWER, not having heard the argument in this case,
did not participate in the decision.
