Pondir v. New York, Lake Erie & Western Railroad — 55 N.Y. St. Rep. 63

Majority

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John Pondir, App’t., v. The New York, Lake Erie & Western Railroad Co. et al., Resp’ts.

(Supreme Court, General Term, First Department,

Filed October 13, 1893.)

Headnote

1. Corporations—Fraudulent transfers.

The acquisition, without adequate consideration, by one corporation of the property of another, in which i’t owns a majority of the capital stock, is, when effected through a board of directors elected and controlled by the vendee company, a fraud upon the vendor company and its stockholders, which, when exposed, should be condemned by the courts, and the parties thereto held to account.

3. Same—Action by stockholders.

The minority stockholders may, upon refusal by the corporation to bring an action to redress such a wrong, maintain the action themselves, either to set aside the deed or for an accounting.

3. Same—Parties.

In an action against the parties to the fraud, to compel them to account as trustees ex maleficio for whatever they have received through the wrongs committed by them, the subsequent grantees and lienors are not necessary parties.

4 Beceiver—Discharge—Accounting.

The discharge of a receiver of a corporation does not relieve him from liability to account as to matters not contained in his accounts.

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5. Pleading—Pabties.

Where a defect of parties defendant is not pleaded, and it should appear that there is a necessity for other parties to the action, the plaintiff not being guilty of laches, the suit should not be dismissed, but the case should be ordered to stand over on proper terms to enable the plaintiff to bring the necessary parties before the court.

Appeal from a judgment dismissing the complaint on the merits, entered on the decision of special term.

This action was brought in January, 1881, by a shareholder in the Buffalo, Bradford & Pittsburgh Bailroad Company, to have a lease executed January 5, 1866, by that corporation to the Erie Bailway Company, and a mortgage executed September 1, 1870, by the latter corporation on the lease-hold interest to the Farmers’ Loan & Trust Company, declared null and void, and.to compel Hugh J. Jewett, as receiver, and the Hew York, Lake Erie & Western Bailroad Company to account and pay over to the Buffalo, Bradford & Pittsburgh Bailroad Company all receipts, profit's and benefits received by them respectively from thé property of the last mentioned corporation while in their possession, and also to reste in the Hew York, Lake Erie & Western Bailroad Company from voting upon the stock held by it in the Buffalo, Bradford & Pittsburgh Bailroad Company.

The following facts are alleged in the complaint and admitted by the answers, or are found by the court and are not challenged by the appellant’s requests or exceptions, or appear on the record and are uncontradicted :

The Buffalo, Bradford & Pittsburgh Bailroad Company was incorporated in 1857, under the laws of the state of Pennsylvania, with a capital stock of $950,000, divided into 9,500 shares, of the par value of $100 each, but its capital, under a provision in its charter, was afterwards, from time to time, increased, so that July ' 27, 1869, it consisted of 28,864 shares, of the par value of $100 each. The 1st day of January, 1865, it mortgaged its property and franchises to Dorman B. Eaton, as trustee, to secure the pajrment of 2,000 bonds of $1,000 each, aggregating $2,000,000. From 1861 until December 25, 1879, the Erie Bailway Company was a corporation, incorporated and existing under the laws of Hew York.

January 5, 1866, the Buffalo, Bradford & Pittsburgh Railroad Company, as party of the first part, and the Erie Bailway Company, as party of the second part, entered into a lease, by which the former leased to the latter for 499 years, from January 1,1866, its railroad and its land, except the following: “ Excepting and reserving, however, unto the party of the first part all the oil underlying the demised premises, or any part thereof, with the right to them, their successors or assigns, to enter upon said premises or any part thereof, to excavate and bore for the said oil, and to erect all the usual structures for raising, receiving, storing, getting ready for market, and taking away and forwarding such oil, and to occupy any part of the demised premises for said purposes, without interfering, however, with the use of the same by the

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party of the second part as a railroad ; and the party of the second part to transport said oil at usual and reasonable rates.”

By this lease the lessee agreed to pay all taxes assessed on the corporation in the states of Hew York and Pennsylvania, and the interest on the mortgage bonds issued under the mortgage January 1,1865, and also the principal of the bonds when they should mature. Ho other rent was agreed to be paid.

The land reserved embraced about 8,000 acres, situated in the county of McKean, in Pennsylvania. When the lease was executed, the Buffalo, Bradford & Pittsburgh Eailroad Company had twelve directors, three of whom were directors of the Erie Eailway Company, one of whom, Eobert H. Burdell, being its president, and another, John Aruot, being the vice-president of the Buffalo, Bradford & Pittsburgh Eailroad Company, and at this date the Erie Eailway Company held 21,875 of the 22,864 shares then outstanding in the Buffalo, Bradford & Pittsburgh Eailroad Company, leaving 989 shares owned by others.

September 1, 1870, the Erie Eailway Company executed a mortgage on the demised property and other property to the Farmers’ Loan & Trust Company to secure the payment of certain "bonds, and on the 4th of February, 1874, it executed a second consolidated mortgage on the demised property and other property to said trust company to secure the payment of $30,000,000 in bonds. In 1875 the trust company brought an action to foreclose the mortgage of February 4, 1874, to which action the Buffalo, Bradford & Pittsburgh Eailroad Company was not a party, in which a judgment of foreclosure and sale was afterwards entered. Hugh J. Jewett was appointed a receiver in this action.

In 1875 the People of the state of Hew York brought an action to dissolve the Erie Eailway Company, because of its alleged insolvency, and May 26, 1875, Hugh J. Jewett was appointed a receiver in that action of the property of the corporation, which action resulted in a judgment entered Hovember 25, 1879, dissolving the corporation, and Jewett was continued as receiver until December 30, 1879, when, having turned over the property to the Hew York, Lake Erie & Western Eailroad Company, he was discharged as receiver.

April 4,1875, the plaintiff purchased, and has ever since owned fifty shares of the capital stock of the Buffalo, Bradford & Pittsburgh Eailroad Company.

December. 30, 1876, the Buffalo, Bradford & Pittsburgh Eailroad company Conveyed the lands and interests excepted from the lease to the Horthwestern Mining & Exchange Company, a Pennsylvania corporation, for the recited consideration of $40,000, but no consideration for this conveyance has been, in fact, paid by the grantee to the grantor. At the date of this conveyance six of the thirteen directors of the Buffalo, Bradford & Pittsburgh Eailroad Company were directors of the Erie Eailway Company, and since the execution of the lease the Erie Eailway Company and its receiver, and the Hew York, Lake Erie & Western Eailroad Company, by virtue of their ownership of a large majority of the shares

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of the Buffalo, Bradford & Pittsburgh Railroad Company, have named and elected such directors as those corporations chose for the lessee company.

On the 30th of December, 1876, the Northwestern Mining & Exchange Company, as party of the first part, entered into a contract in the nature of a lease with H. L. Taylor & Co., as party of the second part, by which the lands conveyed, as aforesaid and other lands, were leased for twenty years to the party of the second part, for the purpose of procuring oil and gas therefrom. The rent or compensation payable was a percentage of the oil and gas that might be produced. Who were the directors of the mining company at the date of the grant does not appear, but the record shows that at the time of the trial of this action, and for several years previous, its board of directors and its executive officers had been filled by the directors and executive officers of the Erie Railway Company and of its successor, the New York, Lake Brie & Western Railroad Company.

April 27, 1878, the New York, Lake Erie & Western Railroad Company was incorporated under the laws of this state, and shortly thereafter it succeeded to all of the property of the Erie Railway Company, including all of its right, title and interest in and to the property leased and conveyed to it by the Buffalo, Bradford & Pittsburgh Railroad Company.

The Northwestern Mining & Exchange Company has a capital of $500,000, all of which is owned by the New York, Lake Erie & Western Railroad Company. On the 13th of May, 1881, the Northwestern Mining & Exchange Company conveyed the eight thousand acres of land and oil rights to the Wilcox & Howard Improvement Company (a Pennsylvania corporation), for the recited consideration of $100 and for other good consideration. On June 28, 1881, the name of the last mentioned corporation was changed to the New York, Lake Erie & Western Coal & Railroad Company. When the last mentioned conveyance was made, the trustees o£ the grantee were not connected with the New York, Lake Erie & Western Railroad Company, but at the date of the trial of this action its trustees were connected with the last named corporation. The New York, Lake Erie & Western Railroad Company owns all of the stock of the Northwestern Minin» & Exchange Company, which corporation owns all of the stock of the New York, Lake Erie & Western Coal & Railroad Company. Since the conveyance of the eight thousand acres of land to the Northwestern Mining & Exchange Company, Hugh J. Jewett, as receiver of the Erie Railway Company, and the New York, Lake Erie & Western Railroad Company, has derived a considerable income from the property. But two dividends have been paid upon the shares of the Buffalo, Bradford & Pittsburgh Railroad Company since that date, one of one dollar per share, paid March 28th, and another of sixty-two cents per share, paid October 9,1885.

Simon Sterne, for app'lt; W. W. MacFarland, for resp’ts.

There is no conflict in the evidence in this case. All of the material facts were testified to by the officers and ein

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ployes of the defendants, who offered no evidence except the order o,f December 30, 1879, discharging Hugh J. Jewett as receiver of the Erie Eailway Company. By the transactions set. forth in the statement of facts, the Erie Eailway Company and its. successor, the Hew York, Lake Erie & Western Eailroad Company, have acquired the property reserved in the lease without any consideration being paid therefor. This was effected through the compliant board of directors of the Buffalo, Bradford & Pittsburgh Eailroad Company, elected and controlled by the Erie Eailway Company, which held a majority of the stock of the Buffalo,. Bradford & Pittsburgh Eailroad Company. By this means the-last mentioned corporation was stripped of all of its property, except that used for railroad purposes, and for the use of which nothing will be paid for 499 years, except taxes assessed on its property and the interest on its debt. This renders all of the shares not held by the Erie Eailway Company practically valueless, and that such was the intended effect is apparent from the transactions. This was a fraud on the Buffalo, Bradford & Pittsburgh Eailroad Company and its shareholders. Such frauds are not uncommon in the management of corporations, and when they are exposed should be condemned by the courts and a heavy hand laid upon all who participate in them.

On the 16th of March, 1880, the plaintiff requested the Buffalo, Bradford & Pittsburgh Eailroad Company to bring an action against the Erie Eailway Company to redress the wrongs herein complained of, which request was not complied with, and it is apparent that further application would have been unavailing, for the three defendants appeared in this action by the same attorneys, and served answers in all re-pects alike, except it is alleged in the answer of Hugh J. Jewett that his accounts as receiver have been approved by the court, and that he has surrendered all of the property that came into his hands, and was discharged from his receivership on the 80th day of December, 1879. Under such circumstances an action may be maintained by a shareholder to redress the wrong done to the corporation of which lie is a member. Bri nckerhoff v. Bostwick, 88 N. Y., 52 ; Barr v. N. Y., Lake Erie & Western R. R. Co., 125 id., 263 ; 34 St. Rep., 743 .

In the case first cited it was said : “ The action to recover such losses, as before observed, should in general be brought in the name of the corporation ; but, if it refuses to prosecute, the stockholders, who are the real parties in interest will he permitted to sue in their own names, making the corporation a defendant. 69 H. Y., 154. And that course of proceeding is also allowed if it appears that the corporation is still under the control of those who must he made the defendants in the suit See Butts v. Wood, 37 N. Y., 317 ; Robinson v. Smith, 3 Paige, 222. In such cases, a demand upon the corporation to bring the suit would he manifestly futile and unnecessary. A suit prosecuted under the direction and control of the very parties against whom the misconduct is alleged and a recovery is sought would scarcely afford to the shareholders the remedy to which they are entitled, and the fact that the delinquent parties are still in control of the corporation is

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of itself sufficient to entitle the shareholders to sue in their own name. Hodges v. New England Screw Co., 1R. I., 312 ; Heath v. Erie Railway Co., 8 Blatchf., 347 . If they could not be permitted in such cases to assert their own rights in a court of equity, the directors, so long as they remained in office, could set them at defiance.”

The Buffalo, Bradford & Pittsburgh Railroad Company was not a party to the action for the foreclosure of the mortgage under the judgment in which the property of the Erie Railway Company was sold and acquired by the Hew York, Lake Erie & Western Railroad Company, and the rights of the Buffalo, Bradford & Pittsburgh Railroad Company are not cut off by the judgment and sale, and besides the mortgage was not a lien on the property and rights reserved to the lessor in the lease.

Upon the discovery of the fraud, an action could be maintained by a shareholder (the corporation refusing to sue) to set aside the deed of December 30, 1876, and the subsequent conveyances and liens, but to such an action the subsequent grantees and holders of liens are necessary parties ; or an action could be maintained against the parties to the fraud and those who subsequently aided in its consummation, to compel them to account as trustees ex maleficio for whatever they have received through the wrongs which they committed. To such an action the subsequent grantees and lienors are not necessary parties, for no relief could be granted against them, and in this case, for a stronger reason, the Horth western Mining & Exchange Company and the Hew York, Lake Erie & Western Coal & Railroad Company are not necessary parties to such an action, for the stock of both corporations is entirely owned by the Hew York, Lake Erie & Western Railroad Company.

It is asserted that in no event can Jewett, as receiver, be compelled to account. This may or may not be so. The conveyance of December 30, 1876, by which the Buffalo, Bradford & Pittsburgh Railroad Company was deprived of its property, was executed when Jewett was acting as the receiver of the Erie Railway Company, and for several years he, as receiver, received a portion of the rents and profits of the lands conveyed. We think he should be required to account and to show how these receipts were disposed of. It may be that it will appear that his accounts rendered to the court were so stated that its order approving of his transactions and discharging him will be a defense, but this cannot be determined in advance of the accounting.

Under the evidence contained in this record, we can see no answer to the plaintiff’s claim that the Hew York, Lake Erie & Western Railroad Company should be required to account and pay over to the plaintiff the rents and profits acquired by it through these fraudulent dispositions of the property of the corporation in which the plaintiff is a shareholder.

The defendants not having pleaded that the subsequent grantees of the Buffalo, Bradford & Pittsburgh Railroad Company and the persons and corporations who have acquired liens upon the property were necessary parties, they were not in a situation to ask to

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have the action dismissed on the ground that those corporations and persons should have been brought into the action. Code Civ. Pro., § 499. When a defect of parties is pleaded, and the plea is sustained by the evidence, the court may refuse to allow the cause to stand over and dismiss the suit, but when a defect of parties is not pleaded, and the necessity for other parties to the action appears on the trial, the plaintiff not being guilty of laches, the suit should not be dismissed, but ordered to stand over on proper terms to enable the plaintiff to bring the necessary parties before the court. Colt v. Lasnier, 9 Cow., 320 ; Van Epps v. Van Deusen, 4 Paige, 64; 1 Barb. Ch. Pr., 321; 1 Dan. Ch. Pr. (3 Am. Ed.), 291 et seq.

The judgment should be reversed, and a new trial granted, with leave to the plaintiff to apply to bring in any such additional parties as he may be advised, with costs to the appellant to abide the event.

Yan Brunt, P. J., concurs.