Raht v. Attrill — 11 N.Y. St. Rep. 9

Majority

p. 9

Charles Raht, as Executor of Julius E. Raht, Deceased, v Henry Y. Attrill et al.^[1]

(Court of Appeals,

Filed October 4, 1887.)

Headnote

1, Receiver—Receivers’ certificates—Order authorizing their issue —Mortgagee and bondholders entitled to notice.

A certain corporation was formed for the purpose of improving land and building a hotel thereon. It took the land subject to a mortgage and issued bonds, secured by a subsequent mortgage, to one Soutter as trustee. The corporation failed before the hotel was completed and was indebted in the sum of nearly $300,000 for labor, materials and furniture, which it had no means to pay, A receiver was appointed and a few days thereafter made application to borrow money on receivers’ certificates, and an cider was made ex parte at special term authorizing him to borrow §130,-000, for the “purpose of paying the employees of said company,” and to issue therefor certificates containing on their face a declaration that the debt represented thereby was “a debt of the receiver, incurred for the benefit and protection of the property in his hands, and a first lien thereon prior to the mortgage” made to Soutter to secure the bonds and to the interest on said mortgage. This order was granted in a suit to which neither the trustee of the mortgage nor the bondholders were, at the time, parties, and without any notice of the application for the order having been given to them or any of them. The proceeds of said certificates was used to carry forward the hotel enterprise. The original parties to the suit were the principal stockholder, plaintiff, and the company, which was-sole defendant. Held, that the order was not binding upon the mortgagee or bondholders; that they were entitled to notice and to he heard before their rights under the mortgage could he affected.

p. 10

.2. Same—Rights op holders op certificates.

This action was brought to foreclose the mortgage on the land. After the payment there was a surplus and a reference was ordered to determine the rights of the different parties. Held, that it was open to the mortgagee and bondholders on the hearing before the referee to contest, both on the facts and the law, the order authorizing issue of said certificates.

3. Same—Priority op bondholders to holders op certificates.

The principal controversy on said reference was between the mortgage creditors under the Soutter mortgage and the holders of certificates under said order, there not being enough to pay either in full. Held, that the lien of the mortgage attaches not only to the land in the condition in which it was at the time of the execution of the mortgage, but as changed or improved by accretions, or by labor expended upon it, while the mortgage is in existence; that creditors having debts created for money, labor or materials used in improving the mortgaged property, acquired on that account no legal or equitable claim to displace or subordinate the lien of the mortgage for their protection; that the fact that the company was owing debts for labor created no equity for their payment in preference to the bondholders.

4. Same—Expenses op preservation of property—What are.

It appeared that about 1,000 workmen, whose wages during May, June and July were in arrears, but who had continued work under promises of payment, all of which were broken, had, at the time the order was made, stopped working, but remained on the premises and had become riotous in their language and demeanor and threatened, unless paid, to burn the hotel building, etc., and were only prevented from so doing by the payment of their wages with money advanced on said certificates. Held, that on the merits a case was not made out justifying the order postponing the lien of the Soutter mortgage; that the money was not used for the “ expenses of preservation," which may he incurred by a receiver by authority of the court. (Gases distinguished.)

8. Same—Power op court to pay expenses op receiver out op PROPERTY.

It has become the settled rule when the court takes charge of property through a receiver that expenses of realization and also “ expenses of preservation” may he incurred under the order of the court on the credit of the property and paid out of the income, or, when necessary, out of the corpus of the property before distribution.

■6. Same—Estoppel—What does not amount to.

Soutter (the trustee named in the mortgage), as one of the board of directors and as a stockholder of the company, participated in the a tian of meetings of directors and stockholders, in which the order for the issuing of certificates was approved. Held, that that fact did not estop the bondholders or bar their right to review the action of the court in making said order.

Appeal from an order of the supreme court, general term, second department, reversing an order of Kings county special term confirming the report of a referee as to the distribution of surplus money and directing the distribution thereof.

In February, 1880,'The Rockaway Beach Improvement Company (Limited), was organized under the business corporations’ act, chapter 611, Laws 1875. It bought 100 acres of land at Rockaway Beach, subject to a purchase money mortgage for $72,000, made by Henry Y. Attrill to one Littlejohn, assigned to one Raht, whose executor

p. 11

brought this action of foreclosure. On April 1, 1880, The Rockaway Beach Improvement Company (Limited), executed a mortgage on the same property to William K. Soutter, trustee, to secure the payment of 700 bonds of $1,000 each. Twenty-six of these bonds were disposed of for value, the balance pledged at about fifty cents on the dollar, as collateral for loans to the company. The company became embarrassed, and on August 2, 1880, Henry T. Attrill, a large stockholder, began an action against the company on behalf of himself and all other stockholders who should unite with him, praying for the appointment of a receiver and the dissolution of the company.

The complaint alleged the organization of the company February 16, 1880, with capital stock $700,000; the pledging of $700,000, first mortgage bonds, at fifty cents on the dollar, to secure loans to the company; that there was due $100,000 for materials; on contracts of furniture, $130,000; for wages, $60,000; that the men refused to work; that one-half had left, the others were working on promise of payment; that large sums would be necessary to complete the work; that no provision had been made therefor, nor to meet the maturing loans on bonds, which would be sacrificed; that delay ensued, depreciating the value of the property; that the plaintiff had been unable to get a statement of the affairs of the company, though willing to assist it by large advances; it expressed fears that a continuance of the then improvident management would result in serious loss to plaintiff and the company; that the hotel and land were the only resources for the payment of the company’s debts; that in its then present condition it was wholly unproductive; that the company was insolvent, or nearly so; that this can only be prevented by intervention of the court and appointment of a receiver; and prayed for the dissolution of the company and the appointment of a receiver. Upon this complaint alone Mr. Justice Donohue made an order, August 2, 1880, appointing John A. Rice receiver of all the property and effects of the Rockaway Beach Improvement Company (Limited), to take possession of and administer the same for the benefit of all concerned.

On the 3d day of August, 1880, the same judge made an ex parte order on the affidavit of Benjamin E. Smith, the general manager of the company, authorizing the receiver to borrow $100,000 to pay wages due the workmen and issue certificates therefor, and also borrow $10,000 to purchase materials necessary to complete the hotel.

The affidavit of Mr. Smith was the basis of all the orders for issuing of receivers’ certificates. It was dated August 3, 1880, and was, in substance, as follows: The company is in process of building a hotel, having nearly two thous-

p. 12

and men employed. Owing to the delay in paying, they all, a short time ago, refused to work, one-half left; about 800 were then working under promise of payment; that no provision has been, or can be, made for payment by the company; that if not paid the men will stop work; and this deponent fears a serious disturbance; that it is imperative that the receiver in this cause be authorized to borrow $100,000 to pay the workmen, which can be raised on receivers’ certificates. On the 11th of August, 1880, an ex parte order was made by the same judge, authorizing the issue of receiver’s certificates to the amount of $110,000, to be paid to the employer of the company; said certificates to be first lien upon all the property of the company, and prior to the mortgage to William K. Soutter, trustee. A similar order was made August 17, 1880, limiting the amount of certificates at $130,000. Under this order Dexrell, Morgan & Co., Morton, Bliss & Co., Hatch & Peters took $110,000 of receiver’s certificates at par for cash, and they were awarded the surplus moneys arising out of the sale of the mortgaged premises in preference to the holders of bonds secured by the prior mortgage to W. K. Soutter, trustee. The legality of this decision is the question brought up for review.

In addition to the papers before the court, and on which alone it acted, the holders of the receiver’s certificates sought to sustain their claim by introducing extraneous evidence, to the effect that after the appointment of the receiver and the making of the affidavit on August 30 by Mr. Smith, the workmen were in a state of riot, threatening to fire and destroy the hotel. They refused to take the receiver’s certificates, and mobbed three or four of the men who had done so. That from this cause the property was in great peril. At a mass-meeting of the workingmen they consented that Mr. McDonald should negotiate $110,000 of receiver’s certificates, which he subsequently did, to Drexell, Morgan & Co., and the others, as above stated. There is no evidence that this state of affairs was brought to the attention of the court so that it could exercise its discretion in the matter. This evidence was admitted over appellant’s objection, and forms the basis of a finding in favor of the receiver’s certificate as an equitable lien.

John L. Cadwalader, Clarence D. Ashley, James McNamee, Edward S. Clinch, for app’lts; Lewis Sanders, for resp’ts.

—The scheme set on foot by the principal stockholder, with the consent of a majority of the trustees of the Rockaway Beach Improvement Company, for the administration of its affairs and for the completion, finish

p. 13

ing and operating the hotel through the instrumentality of a receiver appointed by the court, has proved a signal and disastrous failure. The receiver was appointed August 2, 1880, within six months after the organization of the company. Prior to that date, the company had expended more than $350,000, raised on the sale and hypothecation of its bonds, secured by the trust mortgage to Soutter, leaving the hotel building and structures but partially completed, and had exhausted all its available means and was indebted in the sum of nearly $300,000 for labor, materials and furniture, which it had no means to pay. The receiver, a few days after his appointment, made his first application to borrow money on receivers’ certificates, and on the seventeenth day of August an order was made ex parte at special term, authorizing him to borrow $130,000 for the “purpose of paying the employees of said company,” and to issue therefor certificates containing on their face a declaration, that the debt represented thereby was “ a debt of the receiver incurred for the benefit and protection of the property in his hands, and a first lien thereon prior to the mortgage to William K. Soutter, trustee for $700,000, executed April 1, 1880, and to the interest on said mortgage.”

From time to time thereafter, and up to May, 1881, orders of a similar character were obtained, authorizing the issuing of further certificates for money to “furnish, finish and operate the hotel,” also with priority of lien over the Soutter mortgage. Certificates were issued under the various orders to the amount in all of between $350,000 and $400,000, the proceeds of which presumably were used to carry forward the hotel enterprise. In May, 1881, while the Attrill suit, in which the orders were granted, was pending, an action was commenced by the attorney-general to dissolve the corporation. Thereafter, in September, 1881, an action was commenced by Raht, executor, to foreclose the original purchase money mortgage of $72,000, which went to a decree April 10, 1882, and under which the hotel property was sold January 31, 1883, making a surplus of $86,283."39, the distribution of which is the subject of the present controversy.

It will be seen from this general statement that the efforts of the receiver to administer the property “for the benefit of all concerned,” were terminated after a million dollars had been expended in improving it, in a sale of the whole property of the corporation for a sum of less than $200,000, and all that is left from the wreck for the payment of creditors whose aggregate claims exceed $800,000, is the salvage of $86,000.

This case illustrates what I apprehend has been the com

p. 14

mon experience where a court, departing from its appropriate judicial function, has undertaken to manage and carry on the business of a failing and insolvent corporation.

The principal controversy is between the mortgage creditors under the Soutter mortgage and the holders of the $110,-000 of certificates issued under the order of August 17,1880. There is a controversy between the holders of the different classes of certificates. The holders of certificates, issuedunder the orders subsequent to August 17, 1880, insist that they are entitled to share ratably in the surplus with the holders of the certificates first issued, which claim has been adjudicated against them in this action. The question becomes unimportant if it shall be held that the mortgage creditors have the first lien on the fund in question, as their claims largely exceed the whole surplus. Except for the provision in the order of August 17, 1880, giving to the certificates issued thereunder priority of lien to the Soutter mortgage, there of course could be no question as to the right of the bondholders to a preference. As between creditors by mortgage and general creditors, the former are entitled to priority of payment out of the mortgaged property by their contract, and by law of the land. '

The law recognizes the validity of contracts of mortgage and enforces them, subject to certain regulations for the protection of subsequent purchasers or incumbrancers. The lien of the mortgage attaches not only to the land in the condition in which it was at the time of the execution of the mortgage but as changed or improved by accretions, or by labor expended upon it while the mortgage is in existence. Creditors having debts created for money, labor or materials used in improving the mortgaged property, acquire on that account no legal equitable claim to displace or subordinate the hen of the mortgage for their protection. The order of August 17, 1880, assumes to create a prior equitable lien in favor of the holders of certificates. This is put in the order on the ground that the debt authorized was for the benefit and protection of the property. There are no facts recited in the order, nor were any presented to the court in the affidavit upon which the order was granted which offered the slightest justification for subverting and postponing the prior legal lien of the mortgage creditors, without their consent, to the debts authorized to be created by the order. The fact that the company was owing debts for labor, created no equity for their payment in preference to the bondholders. In view of our decision in the case of Metropolitan Trust Co. v. Tonawanda Valley and Cuba R. R. Co. ( 103 N. Y., 245 ; 2 N. Y. State Rep., 69), it is needless to say that however meritorious these claims were, this of itself presented no reason or

p. 15

justification for paying them out of the property of the bondholders by depriving them of the security pledged to them before the labor debts were contracted. The affidavit upon which the order of August seventeen was based shows that the company was in serious financial embarrassment, but falls far short of disclosing any extraordinary emergency which called for extraordinary methods for the preservation of its property. But the validity of the order of August seventeen, so far as it assumes to give priority to holders of certificates to be issued thereunder, was sought to be supported on the inquiry before the referee in the surplus money proceedings on a ground which was not presented to the court when the order was granted. This ground, as stated in the report of the referee, is in substance that a large number of workmen, comprising eight hundred or a thousand men whose wages during May, June and July were in arrears, but who had continued work under promises of payment, all of which had been broken, had reached a state of absolute destitution and, in many cases, of starvation, and that at the time the order was made they had stopped working but remained on the premises and had become riotous in their language and demeanor and threatened, unless paid, to burn the hotel buildings and erections and personal property therein, and the referee found that but for the action of the bankers who took the certificates and advanced the funds by which the receiver was enabled to pay off the arrears of wages, the hotel and other property of the company “would, in all probability, have been destroyed or seriously injured.”

The question presented is whether these circumstances, justified or if presented to the court would have justified, the order preferring advances made thereunder to the lien of the mortgage.

Before coming to this question, however, it is to be observed that the order was granted in a suit to which neither the trustee of the mortgage nor the bondholders were at the time parties, and without, so far as appears, any notice of the application for the order having been given to them or any of them. The original parties to the suit were Attrill, the principal stockholder of the company, who was plaintiff, and the corporation, the Rockaway Beach Improvement Company, which was sole defendant. On the 13th of August, 1880; an order was made on the application of the receiver enjoining certain bondholders named from selling or transferring bonds issued under the Soutter mortgage, held by them in pledge, which order was served on the persons and firms named therein. But so far as appears, they were not made parties to the action, and the order was doubtless procured to arrest the apprehended danger of a

p. 16

sacrifice of the bonds by the pledgees referred to in the complaint. This order gives no intimation of any intention to apply for an order authorizing the issue of receiver’s certificates. Soutter, the trustee under the mortgage, was made a party defendant at a subsequent stage of the action, but after the certificates under the order of August seventeen were issued and the advances made. The granting of the order of August seventeen, without notice to the mortgagee or to the bondholders did not bind them as an adjudication, assuming that the court had jurisdiction to appoint a receiver in the Attrill action, a point which will be assumed without examination. The bondholders, or their trustee, were entitled by the plainest rules of law and justice to notice and the right to be heard before their rights under the mortgage could be effected, and it was open to them on the hearing before the referee to contest both on the facts and the law, the order of August seventeen.

As was said by Blatchford, J., in Union Trust Company v. Illinois Midland Company ( 117 U. S., 456 ): “The receiver or those lending money to him or certificates issued on orders made without prior notice to parties interested, take the risk of the final action of the court in regard to the loans.”

On the merits we are of opinion that a case was not made out either before the court which granted the order or before the referee on this reference, which within any recognized doctrine regulating or defining the power of a court of equity in the administration of property to a receiver, justified the order of August seventeen, postponing the lien of the Soutter mortgage. The power of a court to appoint a receiver when a proper case is presented is undoubted. It rests in the sound discretion of the court.

The power itself, and the object of its exercise, were stated long since with admirable clearness by Lord Hardwicke in Skip v. Harwood (3 Atk., 564), “It is a discretionary power exercised by the court with as great utility to the subject as any authority which belongs to it; and it is provisional only for the more speedy getting of a party’s estate and securing it for the benefit of such person who shall appear to be entitled, and it does not at all affect the right.”

The act of the court in taking charge of property through a receive is attended with certain necessary expenses of its care and custody, and it has become the settled rule that expenses of realization, and also certain expenses which are called expenses of preservation, may be incurred under the order of the court on the credit of the property, and it follows, from necessity, in order to the effectual administra

p. 17

tian of the trust assumed by the court, that these expenses should be paid out of the income, or, when necessary, out of the corpus of the property before distribution, or before the court passes over the property to those adjudged to be entitled.

It is claimed that the money advanced in this case to protect the property from an incendiary burning created a debt for preservation, which may be preferred to the claim of the bondholders. We are of a contrary opinion. No doubt a serious emergency existed, growing out of the discontent and riotous disposition of the workmen. But the state primarily assumes the duty of preservation of public order and the repression and punishment of crime. It enacts laws, constitutes courts and commissions officers to this end. It especially makes provision intended to prevent riots, and it seeks to insure prompt action on the part of local officers and communities by imposing upon the latter pecuniary responsibility for injuries to property caused by riotous assemblages. In this case no attempt, so far as appears, was made by the receiver or by the company to secure the intervention of the public authorities to suppress the apprehended disturbance, or to arrest those who threatened to burn the property of the company. It clearly ought not to have been assumed that the ordinary agencies of the law were inadequaté to the situation, or that the law, operating through its regularly appointed channels, was impotent to control the situation.

It would be difficult to define by a rule applicable in every case what are expenses of preservation which may be incurred by a receiver by authority of the court. It was said by James, L. J., in Regent's Canal Iron Works Co. (L. R. 3 Ch. Div., 43), that “the only costs for the preservation of the property would be such things as the repairing of the property, paying rates and taxes, which would be necessary to prevent any forfeiture, or putting a person in to take care of the property.” Whatever the true limit is we think it does not include the expenditure authorized by the order of August 17, and that such an expenditure is, and ought to be, excluded from the definition. There must be something approaching a demonstrable necessity to justify such an infringement of the rights of the mortgagees as was attempted in this case.

We have not lost sight of the recent very important cases decided in the supreme court of the United States involving the question of the power which may be vested by the court in receivers of insolvent railroad corporations, and the right of the court to provide for the payment of certain debts contracted before or after the appointment of

p. 18

a receiver out of income, and, if that is inadequate, out of the corpus of the property. These cases and decisions are the outcome of the growth of railroad enterprises and business within a comparatively recent period. It has been held that under special circumstances the court may direct the payment of ante receivership debts for labor or supplies, contracted within a limited period before the insolvency, the adjustment and payment of traffic balances in favor of connecting roads, and may direct the receiver to operate the road pending the foreclosure, and to that end purchase-necessary rolling stock for the use of the road, and make repairs and improvements thereon, the expense of which shall be a charge on the property in priority to legal liens. Wallace v. Loomis, 97 U. S., 146 ; Fosdick v. Schall, 99 id., 235 ; Barton v. Barbour, 104 id., 126; Miltenberger v. Logansport R. Co., 106 id., 286; Union Trust Co. v. Souther, 107 id., 591; Burnham v. Bowen, 111 id., 776; Union Trust Co. v. Ill. Midland R. R. Co., supra.

It cannot be successfully denied that the decisions in these cases vest in the courts a very broad and comprehensive jurisdiction over insolvent railroad corporations and their property. It will be found on examining these cases that the jurisdiction asserted by the court therein is largely based upon the public character of railroad corporations; the public interest in their continued and successful operation; the peculiar character and terms of railroad mortgages, and upon other special grounds not applicable to ordinary private corporations.

It was said by Waite, Ch. J., in Fosdick v. Schall, that: “ Railroad mortgages and the rights of railroad mortgagees are comparatively new in the history of judicial proceedings. They are peculiar in their character, and effect peculiar interests,” and it was said in Barton v. Barbour; “ The new and changed condition of things which is presented by the insolvency of such a corporation as a railroad company, has rendered necessary the exercise of large and modified forms of control of its property by the courts charged with the settlement of its affairs, and the disposition of its assets.” These cases furnish, we think, no authority for upholding the order of August 17, or for subverting the priority of lien, which according to the general rules of law, the bondholders acquired through the trust mortgage on the property of the company. It would be unwise, we think, to extend the power of the court in dealing with property in the hands of receivers to the practical subversion or-destruction of vested interests, as would be the case in this instance if the order of August 17 should be sustained. It is best for all that the integrity of contracts should be strictly guarded and maintained, and that a rigid rather

p. 19

fha.n a liberal construction of the power of the court to subject property in the hands of the receivers to charges, to the prejudice of creditors, should be adopted.

There is no ground for alleging an estoppel against the bondholders, barring their right to a review of the action of the court. The claim of estoppel is based upon the assumed fact that the trustee knew that a receiver had been appointed and did not intervene ta prevent the issuing of the certificates. The trustee at the time was not a party to the action and had no notice of the application for the order, or of the issuing of the certificates, until after. He was designated as a trustee by the company before the bonds were issued, and was one of the directors of the corporation, positions which might bring Ms duty and interest into conflict. It would be most unjust, under the circumstances, to conclude the bondholders by his inaction or for the reason that after the advances on the certificates had been made, he as one of the board of directors and as a stockholder of the company, participated in the action of meetings of directors and stockholders in which the order for the issuing of certificates was approved.

We perceive no valid reason why the expenses incurred by the reorganization committee under the reorganization scheme of 1881, and for which it is claimed a large portion of the bonds and other securities was pledged, may not be adjusted in this proceeding and the lien therefor, if any, be enforced. It is claimed that in any event there are certain expenses of the receivership chargeable against the fund in court. We do not perceive upon the facts, presented that this claim has any foundation. However, we think a proper disposition of the appeal will be made by modifying the order of the general term so as to make the reversal of the order of the special term absolute, leaving the parties to apply for a new reference as they may be .advised, on which all questions except that of priority between the bondholders and creditors holding certificates, may be considered.

All concur.