Hollister v. Stewart

On the first argument of this case I read the following opinion, omitting only a portion of the argument as to jurisdiction, which I deem it unnecessary to repeat. Upon the reargument I am contented to stand upon it, and hand it down now as the ground of my vote for affirmance. That opinion was as follows:

The action of the trustees to whom the first mortgage of the

Both sides appeal; the trustees upon the ground that they have in no just sense or respect violated, their duty, but have acted in all things within their powers and wisely for the interest of those whom they were bound to protect, and the plaintiff, who holds bonds secured by the mortgage to the amount of-two hundred thousand dollars, because the General Term modified the judgment by relieving the trustees from personal liability, and from the command to prosecute the foreclosure of the mortgage, already commenced, to an ultimate sale and distribution. To obtain a safe foundation for our judgment, it thus becomes necessary to examine fully the provisions of the mortgage, since the authority of the trustees has no other source, and their duty no other measure.

That mortgage, given for something over eight millions of dollars, was executed by the company substantially for the purpose of obtaining the means with which to construct its road. The security covered not only the line with its rolling stock and stations and other and usual property, but also a valuable land grant, given by the general government to aid in the completion of the enterprise, and conditioned upon its progress toward that completion. All this property, by article second of the mortgage, is pledged to the payment of the interest and principal of the- bonds, and it is made the duty of the trustees to apply the same “ promptly to that purpose,” “ in case of default in any such payment ” by the mortgagor.

But this incumbrance, covering the land grant earned by the corporation, and intended to be utilized by sales as purchasers could be obtained, involved the necessity of an authority in the trustees to release the lands from the hen when the sales were effected. Accordingly, article third authorized the

By article fourth additional strength and protection was given to’the sinking fund through a provision relieving it from the payment of interest on the bonds during the progress of construction except in one emergency. That interest was to be paid by the company, and none of the land proceeds were at any time to “ be appropriated to the payment of interest on said bonds ” unless the treasury of the company should be first exhausted. In that event the sinking fund was permitted to pay accrued interest; not, as we have said, to buy or secure coupons, but to pay and discharge them — and since in so doing the land fund would be bearing the burden

The mortgage then regulated the duties of the trustees in case of default. If such default in the payment of interest continued for six months, the whole principal became due at the option of the trustees, and they were authorized to enter upon and sell the granted lands at public auction; to enter upon and take possession of the railroad and its rolling stock ; to operate and manage the line and apply any surplus over expenses and necessary repairs and improvements to the payment of interest upon the first mortgage bonds “ in the order in which such interest shall have become or shall become due, ratably to the persons entitled to such interest; ” but if the default should continue for a year, then the trustees were authorized to sell the whole of the property, or so much as might be necessary, and apply the net proceeds “ to the payment of the principal of such of the aforesaid bonds as may be at that time unpaid, whether or not the same shall have previously come due, and of the interest which shall at that time have accrued on the said principal and be unpaid without discrimination or preference, but ratably to the aggregate amount of such unpaid principal and accrued and unpaid interest.”

Article 13 required the company to execute such further deeds and assurances as might be needed, and to furnish a full inventory of all the movable property of the company.

Article 16, about which there is serious dispute over its scope and meaning, deals again with the emergency of a default, and makes it the duty of the trustees to exercise their

It is now said, on behalf of the trustees, that this provision gave them a discretion to waive a default in the payment of interest or principal of the bonds, subject only to be controlled by the requisition or vote of a majority in interest of the bondholders. We do not accede to that construction. Provision had just been made, in a preceding paragraph, for the emergency of a default in principal or interest, which imposed the duty of proceeding upon the default on the requisition of twenty-five per cent in interest of the bondholders. That

The mortgage contained a further provision, important to be considered in reaching a determination of the appeal, that neither of the trustees “ shall be answerable except for his own willful default or misconduct.”

Having thus ascertained the authority and duty of the trustees, it becomes necessary to get as clear and definite a view of what they did as can be gathered from the record. And this can only be°done by taking also into view the precedent and concurrent action of the railroad corporation itself.

The mortgage was executed on the 1st day of July, 1871. The company seems at once to have abdicated all its functions beyond merely retaining its corporate existence, for it agreed

They proceeded with .their work; they sold the bonds and bought the maturing coupons, and continued this process until their debt, represented by sncli coupons, amounted to something more than half a million of dollars. Parallel with this accumulating debt the land fund in the hands of the trustees was being filled by the sales of lands, the proceeds of which, in the form of cash, contracts, mortgages and the like, reached what is called a large sum, but which the record does not disclose.

In this condition of affairs,, and while the road was incomplete, and in December, 1874, it became apparent that the contractors were about to fail of performance, and could not continúe to furnish funds for the purchase of coupons. Interest amounting to something over $150,000 was about to mature, and the company’s treasury was exhausted. Indeed, there had never been either treasury or treasure. To meet this emergency the land fund was the sole resource, and was called upon, as by the terms of the mortgage was permitted. What then occurred is involved in so much of confusion and uncertainty from want of details that, to avoid mistakes, we take the facts from defendants’ brief. It declares that “ the contractors, prior to January 1, 1875, had bought up and held as unpaid as against the company $534,869.25 of coupons. To induce and enable the contractors to buy up the coupons maturing January 1, 1875, the land proceeds to the amount of $534,869.25 were assigned and paid to the contractors.” If that be true, the over-due coupons were paid and extinguished and the transfer canceled the debt. So far there is no hint that the assignment was collateral, and the trustees got no power

The Special Term prohibited that action, and declared the new bonds utterly void as against the plaintiff. The General Term concurred in that result, and, on defendants’ appeal, we are to determine whether that decision is right.

It is first met on the part of the defendants by a protest against any exercise of the jurisdiction of the court founded upon the alleged fact of the pendency of the foreclosure suit, with its supplemental bill in the Federal court in Wisconsin.

Ho such defense was pleaded. The plaintiff came to trial without warning or preparation to meet any such issue. We have held, at the present term of the court, that a defense in equity that the court ought to refrain from the exercise of its conceded jurisdiction is never available unless pleaded, and where the anwer is silent, amounts to a submission of the issues to the judgment of the court and a consent that - upon those issues its judgment may be exercised. (Town of Mentz v. Cook.) * * *

The principal relief granted, and which the trustees on their appeal ask us to reverse, is a decree compelling them to! pay the proceeds of the land sales in their hands, and such as; they have misapplied in due and ratable proportion upon the plaintiff’s bonds, and adjudging to be void as against him the new preferred mortgage and the two added securities. That is simply holding the parties to the conditions of the mortgage, and compelling the trustees to act in accordance with the terms of their trust. Í The scheme of reorganization could only be made effective in one of two ways — by the consent of all the bondholders, or by a foreclosure cutting off their lien, and so enabling a new corporation to make its own mortgages in its own way; The plaintiff had a clear right to stand

The trustees defendant had no right in the present ease to

In their letter of March 4, 18S2, they explicitly promise not to apply any of the proceeds of the sinking fund otherwise than to the purchase and redemption of the first mortgage land grant bonds of said company. And in their answers they admit his right as a non-assenting bondholder to his due proportion of principal and interest upon his bonds out of the proceeds of the land grant; and yet they sought to reduce that due proportion by a prior application of more than $100,000 upon the preferred mortgage.

' They endeavor to justify this in various ways. It was argued that since the scheme of reorganization was tantamount to and took the place of a distribution after foreclosure, and on such distribution a court of equity would prefer certain debts and obligations over the mortgage bonds, the trustees were justified in giving a similar preference, and the $400,000 mortgage covered such claims and no others. | To this there are several answers. The trustees are not a court of equity and have no right to award preferences, least of all to anticipate what such a court, with the facts all before it, would or would not do.

But there is no preferred mortgage which has actually taken effect or superseded the original mortgage. The whole scheme of reorganization is in nubibus, and simply proposed and inchoate. The new mortgages are held in escrow and never yet have taken effect by delivery. On the contrary, the bondholders who have exchanged preserve their old bonds as unpaid and uncanceled and living obligations of the company, and upon them thus existing the land proceeds must be applied, and not upon a preferred mortgage held in escrow and which never may become operative through failure of the conditions of delivery

The first two items are the sum of $71,218.15 for interest on unfunded coupons, under scheme of July 1, 1875, and the sum of $24,000 to those who did not fund their coupons, but whose interest upon the certificates remains unpaid. This is an effort to secure for interest upon interest, a preference not only over coupons later maturing, but over the principal of the mortgage itself. Whatever else may be said about it, we may safely assume that it could have no such preference or priority.

The next item is for holders of land income notes, $280,000. So far as these represent an expenditure for completing the road, which is about one-half of the total, it is not at all certain that any court would award a preference. In Dunham v. C. P., etc., Railway Co. ( 1 Wall. 254 ), a mortgage on the road built and to be built, was given its priority of lien upon a part thereafter constructed at the cost of the contractor and under an agreement that he should retain possession until paid. Our own views of such preferences have been recently

So far as the income notes represented the $150,000 of interest coupons which matured in 1875, and which the contractors bought, several suggestions occur to us. While it may be that the over-due coupons bought by the contractors before 1875, were purchases and not payments, because the then owner of plaintiff’s bonds assented to the arrangement, no such fact is proven as to the purchase of 1875. As to those coupons there- is not a word of evidence that those who accepted their money made or intended a sale. (Union Trust Co. v. Monticello & P. J. R. R., 63 N. Y. 311 .) Those coupons as against the bondholders must be regarded as paid. In Ketchum v. Duncan ( 96 U. S. 659 ), where modifying circumstances were shown and the transaction was regarded as a sale, there was yet a very formidable dissent.

But conceding that there was a sale, yet these coupons in the hands of the contractors were not entitled to any preference. (Dunham v. Railway Co., supra.) They were bound by their contract to buy them, and as holders -stood simply like the others. On the basis that the reorganization is meant to be the equivalent of a distribution on foreclosure, so as to open the question of equitable preferences by the court, and such “ arrangement acts ” are a species of “ bankrupt acts ” (Can. Southern v. Gebhard, supra, 535, 541 ), the mortgage explicitly forbids any such preference. The provision in article tenth of the mortgage for payment in the order of maturity relates apparently to the disposition of the earnings of the road and to a case not of ultimate distribution. .

The final item going to make up the preferred mortgage is

We discover, therefore, no ground, legal or equitable, upon which the preferred mortgage can stand as against the plaintiff, and the judgment as modified by the General Term was right, unless those modifications, upon the plaintiff’s appeal therefrom, should be deemed erroneous.

Our consideration of that subject has led us to the conclusion that those modifications should be sustained.

'There is an express finding that the trustees, though acting erroneously, proceeded in good faith) It would be difficult to sustain that finding were it not for the fact that their omission to make payments upon plaintiff’s bonds until after he had sued, has a reasonable explanation. He claimed more than was his right. He sought not only to defeat the effect of the reorganization upon his bonds, but to make that scheme the means of acquiring an undue preference for himself. He claimed to stand as if the whole assenting first mortgage bonds had been extinguished and the proceeds of the land grant and income from earnings were devoted to the few non-assenting bonds alone, and so sought payment in full by reason of the sacrifices of others. He failed in that effort deservedly, and the omission to pay had some excuse in his exorbitant claims and his hostile attitude. We are disposed, therefore, upon the finding of the referee, and the explicit provisions of the mortgage to approve of the ruling of the General Term that judgment should go against the trustees as such and not personally.

More doubt has attended our reflection upon the question of an order to continue the foreclosure, but the complaint is scarcely framed for such relief, and the proofs indicate that it might merely work mischief to one party without producing benefit to the other, and so we concur in the modification made in that respect.

The judgment of the General Term and the order denying the motion to correct and resettle the judgment, should be affirmed.

In this case, which is for the second time presented to the court upon reargum'ent, I agree with Judge Finch’s opinion in holding that the General Term were right in modifying the judgment so that it should be against the trustees, as such, and not personally. As to the point raised by the defendants’ counsel, that there was an absence of necessary parties, I do not think it is tenable and I agree with the views, in that respect, which were expressed in the opinion at General Term. The new preferred bonds represent the land income notes and the trustees being made defendants; with the Wisconsin Central Hailroad Company, all the parties are before the court who are necessary to an adjudication .upon the plaintiff’s cause of action.

As to the objection raised by the defendants’ counsel to the jurisdiction of the court below, I fully agree in the views . expressed in Judge Finch’s opinion. To be available as a defense, it should have been alleged in the answer or suggested upon the trial. Neither course being taken, the parties must be deemed to have waived it and to have submitted themselves to the jurisdiction of the court. The cause of action was one cognizable in itself by the court; for it was based on an alleged violation by the'trustees of their duty towards the plaintiff, as defined by the terms of the trust deed, and the issue formed was, in fact, as to what were the plaintiff’s rights under a construction of the provisions of that instrument. Nor do I think that it is for this court to say, on appeal, the objection not being taken by pleading or motion in the trial court,' that the trial court should, ex pr opr io motu, have dismissed the complaint.

As to the main question in this case, which turns upon the transactions underlying the creation of the new mortgage and .the issues of preferred and serial bonds secured thereby, and their effect upon the plaintiff’s rights as an original first mortgage bondholder, I take a view somewhat different from that expressed in Judge Finch’s opinion, as rendered upon the prior hearing; while concurring in the

A contract was made by the company for the construction of its road, under which the contractors were to receive all the bonds and stock of the company and all the earnings of constructed road during construction. The company retained only its franchises, and the contractors assumed the entire responsibility of raising moneys by sale of these securities. The company never received any money during the period of construction and never paid out any. The contractors sold the bonds they received, and as coupons matured on them took

The legal effect of the arrangement between this company and the contractors was, as between them, to render them the debtors for. the interest maturing during the time the contract was in force, and their purchasing or taking up the coupons was, in fact, the payment or extinguishment of the coupons. The proceeds of the sales of the bonds, and the earnings of the road, were the stipulated sources for the payment of the accruing interest during the construction of the road, and

The arrangement, therefore, which trustees and company united in making, with the object of securing this claim of the contractors for coupons paid by them, by the assignment of the contents of the sinking fund from the possession of the trustees to a third party, was illegal; for the coupons were as absolutely dead in law as though paid directly by the company. over its counter, and the assignment was a direct violation of the agreement in the mortgage. Coming to the consideration of the payment of the $150,000 of interest, about maturing in January, 1875, on the bonds, the situation, as between company and contractors, was, that it was a liability which the

The defendants admit that the contractors were vitally interested in preventing a default and its consequences, and they say that the contractors themselves set about raising the necessary funds to care for the January coupons; but they could not, as counsel claim, use the coupons in their possession, for they were in fact paid as to the company. However, the moneys were raised by the concert of action between contractors, company and trustees, and matters went on until the foreclosure ■ action was commenced by the trustees, upon the default of the company in July, 1875, in December, 1875. Subsequently, and pending the action, the trustees entered upon the property and took possession under that mortgage. While in possession the so-called plan of reorganization was proposed and received the acquiescence of the trustees. It was in reality but a plan

For reasons I have stated, the $280,000 of land income notes, issued against the trust created of the sinking fund proceeds, to aid the contractors, were not preferred debts of the company, and, for reasons stated in Judge Fikoh’s opinion, which I shall not repeat here, the balance of the $400,000 was equally not.i At most, and overlooking the questionable legality of the transactions out of which they arose as claims against the company, they were entitled to the security of the fund pledged as collateral. How could they deserve protection to the extent of being secured by a prior lien on the mortgaged property? The very terms-of the mortgage contemplate no such possibility, and expressly provide that the trustees shall receive for their advances from the sinking fund to pay interest, which the company has not the means to pay, and to secure the first mortgage bondholders, whose security is thus impaired, an income bond, to be redeemed by other bonds secured by a second mortgage of the premises. The'

The trustees should have proceeded with the foreclosuie action, and they had no power to waive subsequent defaults and to release the company from its obligations to their cestuis qui trustent and from causes of action, as they did in 1879. In changing the contract by releasing the company and in j consenting to a new mortgage, under which the claims oil their cestuis qui trustent were deferred in order of payment, the I trustees violated their legal duty to this plaintiff and rendered! themselves amenable to this action. They were vested with no such discretion as would authorize them to change oi impair any legal right of the plaintiff. The mortgage die not confer any such authority, and the consent of everj bondholder could not do so. Their duty to the bondholders was to them severally, and they were not at liberty to follow the advice or wishes of the majority, being still liable to the minority for a faithful administration of their trust. . (Sturges v. Knapp, 31 Vt. 1 .) With the motives of the plaintiff we are not concerned, while he has legal rights which have been disregarded and which his trustees’ action threatens to disregard.

The argument that these preferred bonds worked no harm to the original bondholders I do not regard as sound. They do not equitably represent debts which are entitled to priority of

I have discussed these questions more at length than I had intended and, perhaps, more, in view of the elaborate opinion of Judge Finch, than was absolutely necessary, and I shall add no more. I concur in Judge Finch’s opinion upon all matters which I have not touched upon here, and I agree in his conclusion that the judgment and order appealed from should be affirmed.

Danforth and Peckham, JJ., concur for affirmance of judgment ; Auger, Ch. J., Earl and Andrews, JJ., dissent; the two latter on the ground that the point that the contractors were bound by their contract to pay the interest coupons as their own' debt is contrary to the specific finding, which is supported by evidence, and that it is manifestly improper to affirm the judgment on a question of fact contrary to the findings.

All concur for dismissal of appeal from order.

Judgment affirmed and appeal from order dismissed.