Knickerbocker Trust Co. v. Oneonta, Cooperstown & Richfield Springs Railway Co.

First. Notwithstanding the determination of this court in Townsend "v. Oneonta, Cooperstown & Richfield Springs Railway Company, 88 App. Div. 208 , 84 N. Y. Supp. 427 , that the order authorizing the receiver to issue his certificates for $35,000 was erroneous, and that such certificates were unlawfully issued, it is nevertheless urged by the holders thereof that on equitable principles they should be allowed payment thereof in preference to the bondholders, on the theory that the latter have in fact received the avails of such certificates. When.the claimants purchased those certificates they knew, or by the exercise of reasonable prudence should have known, that the order of the court which authorized them was subject to review and liable to reversal. They cannot be regarded in any more favorable light as against the bondholders than if they had loaned their money to the receiver on. his individual responsibility, and he had used the same to extinguish the interest coupons.

In Union Trust Company of New York v. Monticello & Port Jervis Railway Company, 63 N. Y. 311 , 20 Am. Rep. 541 , it appeared that one Smith had agreed with the president of the railway company and the trustee of the mortgage bondholders- to advance the money to pay

“Here the holders of the coupons did not agree to assign or transfer them to Smith, and did not in fact do so. When they delivered these coupons to the trust company they supposed they were receiving payment of them, and Smith undoubtedly knew this. He, however, intended to take and hold them, and keep them in being as his security for the money advanced. This he could do as against the railway company; and as against it the mortgage could be enforced for his benefit. It had not paid the coupons, was in no way harmed by their payment by Smith, and he advanced the money for its benefit upon the request of its principal officer. But a different rule applies as between Smith and the bondholders. They had a direct interest in having the coupons paid, so as to preserve the value of their security. They delivered them up to the trust company for payment, and supposed they were paid. If they had known the true state of the case, they might, and probably would, have refused to assign the coupons, and to have them kept in life, and thus, by an accumulation of interest, to have impaired the value of their security. And they could have caused a foreclosure of the mortgage for default in the payment of the interest. * * * The bondholders did not agree that Smith should take and hold the coupons, and they did not agree that he should have any interest in the mortgage security. To give him the benefit of the security would now be detrimental to them, and as between them and him would be inequitable.”

The position of Smith in that case was certainly as favorable as that of the certificate holders here. He had an express agreement with both the railway company and the trustee that he was to hold the coupons as security. Here there was no such agreement, but the certificate holders relied exclusively on an order of the court which erroneously declared the priority of their certificates. That order expressly stated that the receiver was ‘‘to pay the interest.” There was no expectation on the part of the bondholders, the receiver, or the certificate holders that the coupons were to be transferred or held as security or to be treated in any other way than as extinguished.

In Morgan’s Louisiana & Texas Railroad & Steamship Company v. Texas Central Railway Company, 137 U. S. 171 , 11 Sup. Ct. 61 , 34 L. Ed. 625 , it appeared that the Houston Company, under which plaintiff claimed, had made advancements to the defendant railway corporation to be used for operating expenses and other necessary expenditures and to be repaid out of the earnings of the railway. The defendant company had used a portion of said earnings for the payment of coupons of its mortgage bonds although the holders thereof were only entitled to receive payment after the defendant had paid the amounts advanced as aforesaid. It was claimed that the plaintiff was entitled to stand in the place and stead of said mortgage creditors for the amounts received. Chief Justice Fuller writing for the court said:

“It appears that the gross earnings were each year sufficient to pay the operating expenses and taxes, and that the deficit of each year was produced by the payment of interest on the bonded debt. But if the advances could therefore be treated as having been specifically procured for, or specifically

applied to, the payment of interest as such (although there is no evidence to that effect), still such payment would afford no basis for the assertion of a preference as against the bondholders. So far as disclosed, the interest coupons were paid, not purchased (Ketchum v. Duncan, 96 U. S. 659 [ 24 L. Ed. 868 ]; Wood v. Guarantee T. & S. D. Co., 128 U. S. 416 [ 9 Sup. Ct. 131 , 32 L. Ed. 472 ]), and cannot be set up as outstanding; and the contention is wholly inadmissible that the bondholders, because they received what was due them, should be held to have assented to the running of the road at the risk of returning the money thus paid, if the company, by reason of unrealized expectations on the part of those who made the advances, should ultimately turn out to be insolvent and unable to go on. By the payment of interest, the interposition of the bondholders was averted. They could not take possession of the property, and should not be charged with the responsibility of its operation.”

It thus appears on well-settled authority that the claims of the certificate holders, regarding them as they must be regarded, as merely unsecured advancements to the receiver, cannot be given priority over the bondholders. But viewing these certificates in any aspect whatever, it is difficult to see what equitable claim they have to priority over the bonds. It is urged that the bondholders should have returned the money, and that.not having done so they are estopped from repudiating the certificates. They resisted the certificates and took the money not voluntarily, but because it was forced upon them, and by reason thereof lost their right to foreclose their mortgage and to declare the full amount of principal due. They also lost their right to have a receiver appointed who might have superseded the receiver in the sequestration action. When the validity of those certificates was before this court in the Townsend Case, 88 App. Div. 208 , 84 N. Y. Supp. 427 , it was said:

“The mortgagee’s right to declare the principal of the mortgage debt due on default is a part of the contract entered into between the mortgagor and mortgagee, and the right to be heard in the control of the mortgaged property in case of default is a part of the security given to the bondholders by the terms of the mortgage itself.” ■

A return of the money would have been to their prejudice. They could not place themselves in the position in which they were when it was forced upon them. Their status in regard to the litigation and in respect to the receivership was radically changed. The time of payment of their mortgage was postponed. Other interest accumulated in the place of what had been paid. The receivership.in the sequestration action was- protracted, and it is impossible to see in what particular or to what extent their rights have been affected. Under such circumstances very clearly they were not required to restore what they had received. These claimants may have some remedy against the receiver and the property which he represents if there be sufficient in his hands for that purpose. But whatever the remedy mav be it does not extend to the displacement of the mortgage security or affect the contract rights of the bondholders under such mortgage.

Particular stress is placed on the fact that the certificate holders relied on the order of the court. I have attempted to demonstrate that they took their chances of a reversal of this order and that such order erroneously granted resulted in placing the bondholders at a disadvantage in respect to the pending litigation. Irrespective, how

“The two drafted men who appealed from the judgment had no contract relations with the plaintiff; they owed to it no duty, express or implied. There is no privity between them and the plaintiff. The plaintiff did not pay to them, any money at any time. What the plaintiff did was to loan money to a municipal corporation on void securities which the plaintiff could recover so long as it remained under the control of the borrower, but when the town in this case disbursed the money for the purpose for which it was raised, to various persons who claimed and received it as a right, the rule referred to will protect the defendants. The plaintiff advanced the money to the town on its bonds for the very purpose of enabling the town to discharge what was supposed to be its obligation to the drafted men, and the latter received the money by virtue of the law as it then existed under a claim of right. All parties supposed at the time that the drafted men were ■entitled to the money, and that it was their legal right to receive it. It now-turns out that they were all mistaken, but it was a mistake of law, and therefore the drafted men who received the money under the circumstances are nqt under liability to the plaintiff to restore what they have received.”

It seems to me that the analogy between that case and this is complete. In that case money had been advanced on bonds, the proceeds •of which were paid over to certain individuals, and the bonds were subsequently declared illegal because of the unconstitutionality of the statute under which they were issued. In this case money was advanced on receiver’s certificates, the proceeds of which were paid over to certain individuals, and "the certificates were subsequently declared illegal because of the error of the court in authorizing them. In that case the mistake consisted in regarding as valid an act of the Legislature ; in this case the mistake consisted in regarding as valid an order of the court. But in both cases the mistake was one of law, and, if there could be no redress in the one case as against the persons eventually receiving the money, I can see no grounds for similar redress in the other case.

The case of Title Guarantee & Trust Company v. Haven, 196 N. Y. 487 , 495, 89 N. E. 1082 , 1085, has no application to the facts in this ■case for two reasons. First, because the payment was made on a forged check constituting clearly a mistake of fact and not of law; and, secondly, because the payment discharged an assessment which

“Far from disturbing the defendants’ affairs it aided the defendants to perform their contract to convey the premises free from encumbrances.”

Second. The claims for operating expenses of the railroad rest on a different basis. The parties have stipulated “that the materials which were furnished by the creditors were necessary, and used by the receivers in the operation and construction of the railway property, and were of the reasonable value as found by the referee.” That stipulation, however, does not concede that the receivers had the right to operate the road at a loss or to make the expenses thereof a lien on the property prior to the bondholders. It would be a useless task to attempt to harmonize the conflicting dicta in the opinions of courts of the various jurisdictions in respect to the propriety of giving such claims priority over mortgage bondholders. An investigation will disclose that'many apparent differences of opinion arise from the fact that special equities peculiar to particular cases have sometimes controlled the decisions actually made, and given rise to such apparent differences of opinion. The question now before uS must be determined with reference to its particular circumstances. There are in this case facts of a special nature which must be considered in reaching a conclusion.

The bondholders and their trustee did not consent to the appointment of the receiver appointed July 4, 1903, but, on the contrary, sought to have him superseded by a receiver appointed in an action to foreclose the mortgage. This effort on their part, was defeated by the receiver, and improperly so, as this court has held in the Townsend Case, 88 App. Div. 208 , 84 N. Y. Supp. 427 . Thereafter the trustee instituted a proceeding to remove the receiver, which proceeding was pending at the time the voting trust agreement was made in January, 1904. That agreement contemplated the adjustment of all differences between the parties, and, when it was executed, the pending proceeding for the removal of the receiver was discontinued. On February 10, 1904, the court made an order based on that agreement authorizing the receiver to issue certificates to the extent of $250,000, and limiting the üse which was to be made thereof to the general purposes expressed in the agreement as heretofore set forth. Nowhere in the record does it appear that the bondholders have otherwise enlarged the powers of the receiver or in any manner consented that he transcend the limits of said agreement and order. A fair construction of that agreement and order is that the receiver bound himself with the bondholders not to create any charges in excess of $250,000 which should become chargeable against the property of the railroad company prior to the lien of the bonds. The agreement contemplated the expenses of operation of the road, and it clearly became the duty of

Our attention is called to the fact that in an order authorizing the receiver to enter into this voting trust agreement there was a provision that it should be without impairment to “the rights and powers of said receiver in the premises, and any and all acts done or to be done by him in the management and control of said road under his said appointment.” That provision was evidently intended for the benefit of the receiver, and to protect him in whatever rights he might have. But the order was ex parte, and whatever its force it clearly did not affect the rights of the bondholders under their contract with the receiver. Undoubtedly the order of February 10, 1904, rested entirely on the consent of the bondholders, and was limited in its effect to their consent. That was substantially so declared when those certificates were before this court in the case of Rochester Trust & Safe Deposit Company v. Oneonta, Cooperstown & Richfield Springs Railway Company, 122 App. Div. 193 , 107 N. Y. Supp. 237 . Presiding Justice Smith there said:

“It is objected that the order was improvidently made; that the completion of this road was not germane to the preservation of the property. If this were an open question I should incline strongly to approve of the defendants’ contention. The power to authorize construction should be most ■cautiously exercised, and should only be exercised when the cost is limited and the promise of return abundant. If objection had been made at Special Term, tlhe order for the issuance of the certificates for this purpose would probably never have been made. It was granted, however, without objection •on the part of the bondholders, in a proceeding to which they were parties, and in which they in effect joined in the application for their issuance.”

That being the case, it is proper that the receiver should be held strictly to his contract with the bondholders. In Farmers’ Loan & Trust Company v. Bankers & Merchants’ Telegraph Company, 148 N. Y. 315 , 42 N. E. 707 , 31 L. R. A. 403 , 51 Am. St. Rep. 690 , it was said:

“The right of a creditor of an insolvent corporation in the hands of a receiver, to have a preference over bondholders under a first mortgage is strietissimi juris.”

I think, moreover, that when that agreement was made by the receiver whereby all differences were adjusted and the effort to remove him was abandoned, and the bondholders had, as they supposed, limited their liability, the receiver became something more than a receiver. He thereby assumed contract obligations with the bondholders. They •entered into a contract with him on condition that their mortgage should not be displaced except to the extent of $250,000. The receiv

We are unable to see how these claims can be awarded priority over the bondholders without doing violence to what was clearly an intention and understanding between them and the receiver when they gave to him their consent that he might continue the operation of the road and complete its construction. Such consent was evidently given on the plain condition that ho priority should be created over these bonds except to the extent of $250,000. Equity will not under such circumstances permit obvious contract obligations to be disregarded.

The order must be reversed, with $10 costs and disbursements, and the matter remitted to Special Term.

SMITH, P. J., and KEEEOGG, J., concur.

I agree, with Mr. Justice COCH-RANE in his conclusion that under the circumstances surrounding the making of the order permitting the receiver to issue certificates to the extent of $250,000, he was not thereafter justified in exceeding that sum even for paying the necessary running expenses of the road, and hence that the court erroneously directed the payment of certificates amounting to $25,471.84.

I am unable, however, to concur with him in a reversal of the order so far as it affects the certificates amounting to $35,000 which were issued by the receiver pursuant to the order of July 30, 1903, which order was subsequently reversed by this court. 88 App. Div. 208 , 84 N. Y. Supp. '427. To the extent at least of the $32,936.72 which went directly to pay interest on the bonds due May 1, 1903, the holders of the certificates should be protected. The trustee which represented the bondholders was before the court on the making of that order. The order was not void for lack of jurisdiction, but was a good order until it was reversed and protected all parties. The certificates were issued before the reversal, and the purchasers and holders of them were innocent parties, and under no contractual obligation to pay interest on the bonds. They purchased the certificates before the order was reversed, and the money which they paid for them- went direct to the trustee of the bondholders to pay past-due interest on the bonds. It was on the appeal of the trustee representing the bondholders that the order was reversed. If the transaction had been direct between the parties to the action, and the money had been paid pursuant to the direction of an order, the court would have ordered restitution upon reversal. But the money in the present instance was furnished by an innocent third party. The trustee represented the bondholders, and received and- retained the money of such innocent third party and ap

The situation presented is not such as existed in Union Trust Company v. Monticello & Port Jervis Railway Co., 63 N. Y. 311 , 20 Am. Rep. 541 , where an unauthorized attempt was made to sell or pledge the coupons without the knowledge and against the will of the bondholder. Nor is it like Morgan’s Co. v. Texas Central Railway, 137 U. S. 171 , 11 Sup. Ct. 61 , 34 L. Ed. 625 , where the money was simply loaned for general or specific purposes of the corporation with the expectation of repayment from operation of the road; nor similar to the Newburgh Savings Bank v. Town of Woodbury, 173 N. Y. 55 , 65 N. E. 858 , where the plaintiff loaned money to a municipality which voluntarily paid it over under a void law to third parties with whom neither the town nor the plaintiff had any privity as the courts finally determined. In the present case it was the duty of the receiver to pay the coupons of the bondholders because they were legal obligations of his railroad. He sold the certificates to do so but it turned out the court made a mistake in ordering him to do it. It was a mistake of fact, or of law and fact combined. The mistake was certainly mutual as between the receiver and the purchasers of the certificates, and the latter advanced their money in good faith relying upon the validity of an order which was finally held to have been improperly granted.

The avails of the certificates to the extent of $32,936.72 having gone directly to pay the indebtedness held by the bondholders against the railroad, I think to that extent the court was right in directing priority in distribution over the bonds.

I therefore vote for a modification of the order as indicated instead of for reversal.

SEWELL, J., concurs.