1. A sale, far below value, of a railroad, with its franchises,
rolling stock &c. under a decree of foreclosure, set aside as
fraudulent against creditors, the sale having been made under a
scheme between the directors of the road and the purchasers by
which the directors escaped liability on endorsements which they
had made for the railroad company. And the purchasers held to be
trustees to the creditors complainant for the full value of the
property purchased, less a sum which the purchasers had actually
paid for a large lien claim, presented as for its apparent amount
but which they had bought at a large discount. Interest on the
balance, from the day of purchase to the day of final decree in the
suit, to be added.
2. But because the full value of the property sold was not shown
with sufficient certainty, the case was sent back for ascertainment
of it by a master.
The case was this:
Bailey & Co., of Liverpool, England, held notes against the
Milwaukee & Superior Milwaukee & Superior Railroad Company,
endorsed by four of its directors, for about $21,000 (the price of
iron furnished to lay the road), and as collateral security for
payment, $42,000 in mortgage bonds of the road. Two hundred and
eighty thousand dollars in similar bonds, but which had never been
issued, were sealed up and deposited with M. K. Jesup & Co.,
not to be issued until the debt to Bailey & Co. was paid and
twenty-seven miles of the road were built. The company was managed
by a board of seven directors, of whom four made a quorum.
Page 74 U. S. 300
The company, having made about five miles of the road, became
thoroughly insolvent and abandoned their enterprise. Bailey &
Co., being unpaid and not being willing to trust to and proceed on
their mortgage, brought actions against the four directors on their
endorsement. These, desirous to throw the debt on the company,
where it belonged, procured, at their own expense and risk, a suit
to be commenced to foreclose the mortgage so that they could make
their debt out of the collaterals in their hands. In this suit,
certain bonds issued to the City of Milwaukee, and the $42,000 of
bonds held by Bailey & Co., were spoken of, but no mention was
made of the $280,000 of bonds deposited with Jesup & Co., and
no relief asked in relation to them. On the 19th of March, 1859,
the bill was taken as confessed, decree rendered, and the case
referred to the master to compute and report the amount that was
due.
Prior to the decree, in consequence of negotiations between the
directors and Cross, Luddington & Scott (Cross & Co), an
arrangement was made by which these persons were to purchase the
claim of Bailey and protect the directors from their endorsement.
The directors, on their part, were to aid Cross & Co. to
acquire the entire property of the road.
In furtherance of this plan, the $280,000 of bonds in the hands
of Jesup & Co. were delivered, by resolution of the board of
directors, to Bailey & Co. as additional security for their
claim. Bailey & Co. did not ask for further security, and
refused, at first, to receive these bonds, and in fact did not
receive them until they had sold their claim, with their
collaterals, to Cross & Co. This was after the decree in the
foreclosure suit. Cross & Co. having thus got possession of
$322,000 in bonds, transferred by Bailey & Co., as collaterals,
in order, as they said, to become the absolute owners of them, sold
them, with consent of the railroad corporation, at the Exchange in
Milwaukee, on five days' notice; bought them for a small sum of
money; produced them before the master, who allowed them as a lien
on the road, and the final decree in the foreclosure suit was
rendered upon the said $322,000 bonds, and no others.
Page 74 U. S. 301
The sum paid by Cross & Co. to Bailey & Co. for all the
judgments obtained was $13,380.20.
Under the decree of foreclosure, the entire railroad, its
franchises, rolling stock (two locomotives and tenders, with ten
platform cars) and fixtures were sold in August, 1859, to Cross
& Co., for $20,100. The iron tracks, which were now torn up,
some evidence showed had been sold for $22,500. The locomotives
(little used) had cost $18,000; the cars about $5,000. The company,
it was said, had paid between $15,000 and $20,000 for their right
of way. There were also railroad chairs, spikes, ties, some fences
&c., the value not being exactly shown.
In this state of things, Drury & Page, having obtained
judgment for $21,634 against the railroad company for locomotives
sold to it, filed a bill in chancery in the court below against the
company, Cross and his co-purchasers, alleging that the sale was
fraudulent and seeking to reach the franchises and property of the
company sold to Cross & Co. under the decree of foreclosure.
The court below dismissed the bill as to Cross and his
co-purchasers, and from this decree of dismissal the present appeal
came.
Page 74 U. S. 302
MR. JUSTICE DAVIS delivered the opinion of the Court.
The transaction which this case discloses cannot be sustained by
a court of equity. The conduct of the directors of this railroad
corporation was very discreditable and without authority of law. It
was their duty to administer the important matters committed to
their charge for the mutual benefit of all parties interested, and
in securing an advantage to themselves not common to the other
creditors they were guilty of a plain breach of trust. To be
relieved from their endorsement, they were willing to sacrifice the
whole property of the road. Bound to execute the responsible duties
entrusted to their management with absolute fidelity to both
creditors and stockholders, they nevertheless acted with reckless
disregard of the rights of creditors as meritorious as those whose
paper they had endorsed. If Bailey & Co. had sold iron to build
the road, so had the Boston association sold locomotives to run it.
It is not easy to see why the corporation should exhaust its
effects to pay one and leave the other unpaid. But, it is said, the
directors, being unable to pay both, had the right to choose
between them. We do not deny that a debtor has a legal right to
prefer one creditor over another when the transaction is
bona
fide, but
Page 74 U. S. 303
this is in no just sense a case of preference between creditors.
If the law permits the debtor in failing circumstances to make
choice of the persons he will pay, it denies him the right, in
doing it, to contrive that the unpreferred creditor shall never be
paid. In other words, the law condemns any plan in the disposition
of property which necessarily accomplishes a fraudulent result.
That the plan adopted by the directors of this railroad to
dispose of its property to Cross & Co. was a fraudulent
contrivance, and necessarily, if executed, accomplished a
fraudulent result is too plain for controversy. At the time this
scheme was initiated, there were only five miles of track laid, the
company hopelessly insolvent, and the enterprise abandoned. In this
condition of things, the directors were sued on their endorsement,
and, as was natural, manifested an anxiety to have the property of
the company pay the debt for which they were liable. But Bailey
& Co. preferred not to enforce their mortgage lien, and only
consented to allow it to be done on being indemnified against the
risk and expense of the suit. The directors, in furnishing them
this indemnity in order to procure the enforcement of the mortgage
lien to the extent of $42,000, which in their hands was a just debt
against the company, were guilty of no wrong. But the departure
from right conduct on their part commenced at this point.
Notwithstanding they had the control of the foreclosure suit, they
were not content to let it proceed to decree and sale without they
were, in advance, relieved of personal responsibility. Bailey &
Co. would not release them, and they endeavored to find some person
who would purchase the Bailey claim, with its collaterals, and
discharge them from liability on their notes. This would have been
well enough if the scheme had embraced only the $42,000 bonds held
as collaterals which the company justly owed and the foreclosure
suit was brought to enforce. But the scheme went much further, for
these directors, who controlled the corporation, in their selfish
desire to save themselves at the expense of their own reputation
and the rights of creditors, were willing to use the
Page 74 U. S. 304
means at their command to swell the indebtedness of the road
beyond its true amount in order to aid more effectually Cross and
his associates to acquire all the property of the company.
If Cross & Co. had been satisfied with the transfer of the
$42,000 bonds, which constituted the true indebtedness against the
road, in the hands of Bailey & Co., the transaction on their
part would have been free from censure; but the certain attainment
of the object they had in view required more bonds. It was very
clear that bidders might appear if the road was to be sold for no
more than the face of these bonds, while they would be deterred
from attending a sale where the sum to be made was over $300,000.
To bring the decree, therefore, up to a point at which competition
would be silenced, it became necessary to use the bonds in the
hands of Jesup & Co. Two hundred and eighty thousand dollars in
the bonds of an insolvent corporation -- constituting no
indebtedness against it -- are thrust, unasked, into the hands of
creditors for the ostensible purpose of furnishing them additional
security when, at the time, they were negotiating a sale of the
debt to be secured for $7,000 less than its face. But the transfer
to Bailey & Co. was a mere pretense. To preserve a semblance of
fairness in the business, the bonds had to come through Bailey
& Co., but the real purpose was not to help them, but to aid
Cross and his associates to absorb the whole road -- and this these
directors were willing to do -- when the debt they were struggling
to escape could be paid for $13,380.20, and the very iron in the
roadbed, for which the debt was incurred, was worth over
$20,000.
It is claimed that the sale at the Milwaukee Exchange, assented
to by the corporation, conferred rights on the purchasers of the
bonds which cannot be successfully attacked; but this claim is
based on the idea that the sale was for an honest purpose, when in
fact it was only part of a previously concerted plan to accomplish
a fraudulent purpose. The ceremony of this sale was a cheap way of
showing honesty and fairness, for it was very evident that an
advertisement
Page 74 U. S. 305
to sell a large amount of the bonds (having no market value) of
an insolvent and abandoned railroad corporation would never attract
the attention of capitalists.
The scheme to acquire the property of this corporation was in
its inception fraudulent, and every step in the progress of its
execution was necessarily stamped with the same character. There is
nothing in this record to mitigate the conduct of the defendants,
who purchased the Milwaukee & Superior Railroad. They knew the
road was abandoned, the company insolvent, the complainants unpaid
for property then in the possession of the corporation, and yet
they combine with timid and unfaithful trustees to get not only
this, but all the property of the corporation, and adopted a plan
to carry out their project which resulted in raising the decree to
an extent that would necessarily prevent all fair competition. The
fruits of such an adventure cannot be enjoyed by the parties
concerned in it.
There are other features in this case which provoke comments,
but we forbear to make them.
Cross, Luddington, and Scott purchased the entire railroad,
locomotives, cars, and franchises of the company for about $20,000.
Subsequent to the sale, they stripped the roadbed of iron, ties,
spikes, and chairs, which, with the locomotives, cars, and fencing,
they sold to various parties and realized from the sales a large
sum of money, but how much the evidence is so singularly loose that
we are unable to tell. On account of the want of certainty on this
point, the case will have to be sent back and referred to a master
to take proofs, who will also ascertain and report the value (if
there by any) of the franchises of the company which Cross &
Co. still retain.
Cross, Luddington, and Scott must be held liable as trustees to
the complainants for the full value of the property they purchased
on the sale of the road, after deducting the amount due at the day
of sale on the Bailey judgments against the directors, which amount
they will be allowed to retain.
Page 74 U. S. 306
They must also be charged with interest on the balance found due
the complainants from the day of the sale to the day of the final
decree in this suit.
The decree of the circuit court is reversed and the cause
remanded with directions to proceed in conformity with this
opinion.
