Morgan's Company v. Texas Cent Railway Company/Opinion of the Court

The objection that the Farmers' Company could not proceed to a foreclosure and sale to pay the principal as well as the interest of the bonds upon a default in the payment of interest, without averring and proving that the bill had been filed for that purpose by the request of the holders of 75 per cent. in amount of the outstanding bonds, rests upon the language of the conditions of the mortgages. Each of them, after providing that it should be void in the event that the railway company should pay the principal of the bonds and the several installments of interest as they became due, stipulated as follows: 'But in case the Texas Central Railway Company shall fail to pay the principal, or any part thereof, or any of the interest on any of the said bonds at any time when the same may become due and payable according to the tenor thereof, and if the said default shall continue sixty days after having been demanded, then and thereupon the principal of all the said bonds hereby secured shall be and become immediately due and payable, ad upon the requst of the holder or holders of seventy-five per cent. of said bonds then outstanding, and written notice of said request being served on the New York agency of the party of the first part, at which said bonds and coupons are made payable, the said trustee, (who may act by its president or attorney,) or its successor or successors in this trust, may and shall take actual possession (with or without entry or foreclosure) of said railway hereby conveyed, and of all and singular the said mortgaged property, and shall manage and operate the same, and receive all the income and profits of the same, together with all the books, papers, records, accounts, and money of said railway company, first defraying out of the same the expenses of the road and its needful repairs and the management of said trust, and the surplus to pay the interest and principal of all the bonds issued hereunder which may be due and outstanding and hereby secured pro rata; and, upon request of the holder or holders of seventy-five per cent. in amount of the bonds so in default which may be at any time outstanding under this deed of trust, it shall be the duty of the said Farmers' Loan & Trust Company of the city of New York, by its president or agent duly appointed in its behalf, to foreclose this mortgage or deed of trust, and sell the property herein and hereby conveyed, at the city of Houston, Texas, at public auction, to the highest bidder for cash, after having given at least sixty days' notice of the time, place, and terms of sale by advertisement in at least two daily newspapers published in the city of Houston, and two daily newspapers published in the city of New York,' etc. It is contended on behalf of the appellants that, by the true construction of the foregoing conditions, the action of the trustee in enforcing the stipulation that, upon the prescribed default in the payment of the interest, the principal of the bonds should become due, is so far subjected to the wishes of the bondholders that the trustee is without right or power to institute proceedings for the collection of the principal sum before the date of payment in course, by foreclosure and sale upon such default on interest, except upon the request of the holders of 75 per cent. in amount of the bonds outstanding. We do not agree with this view. Whenever default upon the interest should continue 60 days after maturity and demand, then and thereupon it was declared that the principal of all of the bonds should be and become immediately due and payable, and that the trustee, upon the request of the holder or holders of 75 per cent. of the outstanding bonds, and written notice thereof being served on the New York agency of the mortgagor, where the bonds and coupons were made payable, might take possession and operate the road; and upon like request it was made the duty of the trustee to foreclose the mortgage and, after advertisement, sell the property at public auction to the highest bidder for cash. Hence, although, as to the particular form of foreclosure and sale at public auction by advertisement, and without the aid of the court, the proper construction would be that that course could not be taken without the request prescribed, this not only did not limit the power of the trustee to proceed by application to a court of equity to foreclose, but each of the mortgages contained near its close the following clause: 'It is hereby further agreed that nothing herein contained shall be held or construed to prevent or interfere with the foreclosure of this instrument, the appointment of a receiver, or any other act or proceeding appropriate in such cases, by any court of competent jurisdiction.' There was nothing in the mortgages which took away the inherent right of resort to the courts, and this clause did not impart what existed without it, but its insertion, evidently out of abundant caution, made it perfectly clear that the provisions relied on by appellants did not apply to foreclosure by bill n equity, but to the cumulative remedy specified. It is easy to see why taking possession and selling without the intervention of the court should be guarded against, and the trustee not be required or allowed to proceed in that summary manner except on the request of a certain percentage of the holders of the bonds. Such proceedings might result in injury which could not be predicated of those regularly taken in a court of equity. Arbitrary procedure by the trustee was not deemed desirable, in view of the interests of both mortgagor and the bondholders as a class, while each would find the protection to which it might be entitled at the hands of the court. Mercantile Trust Co. v. Missouri K. & T. Ry. Co., 36 Fed. Rep. 221.

The case of Railroad Co. v. Fosdick, 106 U.S. 47, is so different upon the facts from that in hand as to deprive it of the weight attributed to it by appellants. The mortgage in controversy in that suit contained no provision saving to the trustees the right to resort to the courts for a foreclosure. It provided for a remedy in case of default, by entry and sale by the trustees, and also by foreclosure and sale; but it was provided that demand for possession should not be made by the trustees until they were required to take such possession by the holders of at least one-half of the outstanding bonds, and that where there was a default on interest, continued for six months after demand, the trustees might declare the principal due and give notice to the mortgagor, and, upon the written request of the holders of a majority of such bonds, proceed to collect both principal and interest by foreclosure and sale, or otherwise, as provided. 106 U.S. 49, 50. This court held that the restriction on the acceleration of the principal did not prevent a foreclosure suit for overdue interest, and that, as the company in that case was in default on some of the coupons, the trustees or any bondholder, independently of the particular provisions just referred to, on non-payment of any installment of interest, could file a bill for the enforcement of the security, and obtain a decree nisi, for such defaulted interest, and, if the same were not paid as directed, a sale would be ordered. But as the finding of the amount due was the foundation of the right of the mortgagee to proceed, and the right to redeem would not be taken away except upon a strict compliance with the steps necessary to divest it, it became, said Mr. Justice MATTHEWS, speaking for the court, 'of the first importance to ascertain whether the decree of foreclosure and sale, in the present case, found due and required to be paid, as the condition of exercising the right to redeem, a larger sum than was then due.' The evidence being examined, it was found that there was none to establish that 'any coupon, not afterwards funded, was presented, and payment thereof refused;' and it was pointed out that, under the eighth article of the mortgage there involved, (which provided that if default was made in the payment of any half-year's interest on any of said bonds, and the coupons for such interest should have been presented, and such default should have continued for six months after such demand, without the consent of the holder of said coupon or bond, then the principal of all of the said bonds should be and become immediately due and payable, anything in said bonds to the contrary notwithstanding, and that the trustees might so declare the same, and notify the party of the first part thereof,) the forfeiture must stand or fall upon the fact of such declaration and notice, as it might be justified or not by the circumstances existing when they were made, and that, whether the whole debt had become due or not, must rest exclusively upon the alleged default, which had been found insufficient. And it was further held that under the same article which provided for a foreclosure on the written request of the holders of the majority of the outstanding bonds, even if the principal sum oft he mortgage deed had been rightfully declared due and the required notice given, nevertheless the foundation for proceeding to foreclose would fail without proof that the bill had been filed for that purpose upon such written request. In the case at bar, the proof of the presentation and default upon the coupons was full, and was not disputed. The mortgages specifically provided that upon such default continuing for 60 days after demand, the principal of all the bonds should become immediately due and payable. The Texas Company and the Morgan Company both admitted that the principal had become due and payable. The instruments did not require a written request for a declaration by the trustee that the principal was due, or such a declaration and notification to the defaulting company, in order to make the principal mature. That was a consequence of a default continuing 60 days after demand. Nor was there any restriction upon the power to proceed by bill in equity, but on the contrary any intention to impose such a restriction was disavowed. The Morgan Company insisted by its pleadings that it was justly entitled to be paid out of the proceeds of the sale decreed in preference to the first mortgage bonds, because, as it alleged, the Houston Company under which it claims advanced the amount in question to the Texas Company to be used for taxes, operating expenses, equipment, improvements, and other necessary expenditures, by which the Texas Company's railway had been kept in safe running order, its business and importance increased, and it thereby rendered more valuable to the first mortgage bondholders; that the indebtedness was contracted by the Texas Company upon consideration of its promise to pay the same out of the earnings of its railway; that (as is charged upon information and belief) the company had used at least $500,000 of said earnings during the years 1882, 1883, and 1884, for the payment of coupons of its first * mortgage bonds, although the holders of the coupons were only entitled to receive payment thereof after the Texas Company had paid the amounts advanced and paid as aforesaid; and that the Morgan Company was entitled to stand in the place and stead of said mortgage creditors for the amounts received. In other words, the contention seemed to be that the Houston Company should be awarded priority of lien because it advanced the amount in question to be used in the payment of operating expenses and taxes, and it was so used; or upon the promise that it should be so used, which was broken by its deversion to the payment of interest; or, if there was no such promise, express or implied, then, that the application of the advances to the payment of interest entitled the Houston Company to preference by way of subrogation; or because by such payment the Texas Company was kept running for five years, which, without such payment, would have been impossible.

We do not, however, understand it to be claimed upon the evidence that any express agreement is made out for the application of the advances to any particular purpose, or for the right of subrogation between the Houston Company and either the Texas Company or the first mortgage bondholders, or that any of the interest coupons upon the first mortgage bonds, which were paid by the Texas Company, were taken by the Houston Company as security for advances. But it is argued that the advances were for the payment of operating expenses, taxes, and interest during five years, whereby the railroad property was preserved as a 'going' concern; that at the time the road was constructed the country through which it ran was in a prosperous condition, but afterwards unfavorable conditions supervened and continued throughout the period covered by the advances; that 'it was hoped and expected, however, that an improvement in the business of the road would take place, and that the company would be enabled to reimburse the advances;' that the advances were made to meet the particular deficits as they occurred from time to time to pay operating expene § when there was a deficiency in the earnings, and to pay interest on the bonds when there was not enough from the earnings to pay it, and, as a whole, constituted the ways and means of maintaining the good-will and integrity of the enterprise, and preserving the property, business, and franchises; and that, as all that was done by the Houston Company inured directly for the benefit of the public and of the property, it was just and equitable, 'inasmuch as the expectations of the parties in regard to the enterprise were not realized, without any fault of theirs, that the mortgage securities should bear the loss which must be sustained either by the bondholders or the appellant.' From the account stated, 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; Wood v. Trust, etc., Co., 128 U.S. 416, 9 Sup. Ct. Rep. 131,) 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 is true that a railroad company is a corporation operating a public highway, but it does not follow that the discharge of its public excuses it from amenability for its private obligations. If it cannot keep up and maintain its road in a suitable condition, and perform the public service for which it was endowed with its faculties and franchises, it must give way to those who can. Its bonds cannot be confiscated because it lacks self-sustaining ability. To allow another corporation, which for its own purposes has kept a railroad in operation in the hands of the original company, by enabling it to prevent those who would otherwise be entitled to take it from doing so, a preference in reimbursement over the latter on the ground of superiority of equity, would be to permit the speculative action of third parties to defeat contract obligations, and to concede a power over the property of others which even governmental sovereignty cannot exercise without limitation. And if all these advances should be considered as applied in payment of the operating expenses only, upon the theory, where such was not literally the fact, that they supplied a deficit created by the payment of interest out of the gross earnings, the same remarks would be applicable.

The doctrine of Fosdick v. Schall, 99 U.S. 235, is that a court of equity may make it a condition of the issue of an order for the appointment of a receiver; that certain outstanding debts of the company shall be paid from the income that may be collected by the receiver or from the proceeds of sale; that the property being in the hands of the court for administration as a trust fund for the payment of incumbrances, the court, in putting it in condition for sale, may, if needed, recognize the claims of material-men and laborers, and some few others of similar nature, accruing for a brief period prior to its intervention, where current earnings have been used by the company to pay mortgage debt or improve the property, instead of to pay current expenses, under circumstaces raising an equity for their restoration, as, for instance, where the company, being insolvent and in default, is allowed by the mortgage bondholders to remain in possession and operate the road long after that default has become notorious, or where the company has been suddenly deprived of the control of its property, and the pursuit of any other course might lead to cessation of operation. Miltenberger v. Railway Co., 106 U.S. 286, 311, 312, 1 Sup. Ct. Rep. 140. If the officers of the company, remarked Mr. Chief Justice WAITE, in Fosdick v. Schall, 'give to one class of creditors that which properly belongs to another, the court may, upon an adjustment of the accounts, so use the income which comes into its own hands as, if practicable, to restore the parties to their original equitable rights. * *  * Whatever is done, therefore, must be with a view to a restoration by the mortgage creditors of that which they have thus inequitably obtained. It follows that, if there has been in reality no diversion, there can be no restoration; and that the amount of restoration should be made to depend upon the amount of the diversion.' Burnham v. Bowen, 111 U.S. 776, 4 Sup. Ct. Rep. 675; Union Trust Co. v. Illinois M. R. Co., 117 U.S. 434, 6 Sup. Ct. Rep. 809. In the light of these decisions, the inquiry before us is whether these bondholders are to be postponed in respect to the proceeds of the sale of the corpus of the property, upon which their lien is first and paramount, to this claim of the Houston Company, upon the ground of the particular application of these moneys, or that they supplied a diversion by the officers of the Texas Company equitably binding as such upon the bondholders. Now, if these advances were made generally, as needed by the Texas Company, it matters not whether they were devoted to the payment of running expenses or not. The relation of debtor and creditor existed, and no equity could arise in favor of the creditor as against other creditors holding security prior in time, by reason of the voluntary application the debtor might make of the money borrowed. We repeat that, so far as appears, the money advanced to one road by the other was simply a loan. The account between the companies was a running account, and the balance was only a balance for cash advances made from time to time. Moneys received from the operation of the Texas road, and moneys received from the Houston Company, all went into a common fund, from which payments were made for expenses, taxes, and so on. It is also shown that the Texas Company and the Houston Company had the same fiseal agent in New York, who paid the coupons of both; that the management of the Texas Company was, during its entire existence, in the hands of the same officers and directors who managed the Houston Company; that these officers derived their compensation from the Houston Company; that all receipts from the Texas Company were first received by the Houston Company, and then transferred on the books to the treasurer of both companies, as treasurer of the Texas Company; that, whenever there was a deficit of funds on the part of the Texas Company, such deficit was made up by the Houston Company; and that the latter company received and disbursed everything. Under such circumstances, it cannot be maintained, against the first mortgage bondholders, that a balance of such a running account of five years' duration represents money so applied to the current expenses of the road, or so diverted therefrom to the payment of interest on the bonds, as to carry with it a superior equity for repayment. Penn v. Calhoun, 121 U.S. 251, 7 Sup. Ct. Rep. 906; Kneeland v. American L. & T. Co., 136 U.S. 89, 10 Sup. Ct. Rep. 950; St. Louis, etc., R. Co. v. Cleveland, etc., Ry. Co., 125 U.S. 658, 8 Sup. Ct. Rep. 1011. It is to be observed, also, that the Morgan Company counted upon the certificates of the Texas Company, whereby it bound itself to deliver to the Houston Company the third mortgage bonds as so n as executed by the Metropolitan Company as trustee, and asked for a decree against all the defendants, declaring the amount found due to complainant, as holder of such certificates, to be 'a full, complete, perfect, and equitable mortgage and lien upon said railway, and upon all of the property, incomes, tolls, and profits in said deed of trust of October 1, 1885, described,' and prayed 'that, out of the proceeds of any sale which may be made to satisfy any decree of this honorable court, your orator's claim for said amount be paid and satisfied.' It is thus seen that the Morgan Company asserted its equities as based on the third mortgage bonds, which renders it still clearer that upon this record no reason exists for the subordination of the first and second mortgages to this claim. Our conclusion is that the circuit court, while it decreed a lien to the Morgan Company, rightfully refused to give it preference over the paramount lien of the first and second mortgage bonds.

Notwithstanding the decree was properly rendered upon the merits, we are urged to reverse it upon the further ground that the bill of the Farmers' Company ought not to have been allowed to be filed because not in time, and not a cross-bill, and that, if treated as an original bill, it cannot be maintained, for want of jurisdiction, the Farmers' and Metropolitan Companies being citizens of New York, the Morgan Company, of Louisiana, and the Texas Company, of Texas. Under the original bill filed by the Morgan Company, and on its application, the court had taken possession of the property of the Texas Company, through receivers. The Farmers' and Metropolitan Companies were then brought into court by an amended and supplemental bill, which prayed for an account of all liens and incumbrances on the property of the Texas Company, and of all its assets, and for a decree adjudging the sums alleged to be due to the Morgan Company liens upon the net earnings of the Texas Company and all its property, superior in rank to the claims of the said trustees, and of the holders of the mortgage bonds issued under the various deeds of trust, the giving of which had been set up in the original bill, and copies thereto annexed; and that the amount due to it by reason of its advances to the Houston Company should be paid out of the net earnings, and, if they proved insufficient, then that a sale be ordered of the property in bulk, and that the amount decreed to the Morgan Company be paid out of the proceeds in preference to the amounts due on the mortgage bonds. It was also specifically prayed, as has been stated, that the rights of the Morgan Company, under the certificates given it by the Houston Company, in lieu of the bonds issued under the third mortgage, should be decreed to be an equitable mortgage upon the property of the Texas Company, and, inferentially at least, superior to the lien of the first two mortgages. 'A cross-bill,' says Mr. Justice Story, (Eq. Pl. § 389,) 'ex vi terminorum implies a bill brought by a defendant in a suit against the plaintiff in the same suit, or against other defendants in the same suit, or against both, touching the matters in question in the original bill. A bill of this kind is usually brought, either (1) to obtain a necessary discovery of facts in aid of the defense to the original bill, or (2) to obtain full relief to all parties, touching the matters of the original bill.' And, as illustrative of cross-bills for relief, he says, (section 392:) 'It also frequently happens, and particularly if any question arises between two defendants to a bill, that the court cannot make a complete decree without a cross-bill, or cross-bills, to bring every matter in dispute completely before the court, to be litigated by the proper parties, and upon the proper proofs.' It seems to us that in order that a decree might be made upon the whole matter in dispute, brought completely before the court, the bill in question was necessary, and was correctly styled a 'cross-bill.' In no proper sens were new and distinct matters introduced by it, which were not embraced in the original and amended and supplemental bills, and, while it sought equitable relief, it was such as, in point of jurisdiction over the subject-matter, the court was competent to administer. It may be that, so far as it sought the further aid of the court beyond the purposes of defense to the original bill, it was not a pure cross-bill; but that is immaterial. The subject-matter was the same, although the complainant in the cross-bill aserted rights to the property different from those allowed to it in the original bill, and claimed an affirmative decree upon those rights. A complete determination of the matters already in litigation could not have been obtained except through a cross-bill, and different relief from that prayed in the original bill would necessarily be sought. This bill was filed, on leave, before the testimony was taken, and though there should be as little delay as possible in filing bills of this kind, yet that was a matter entirely within the discretion of the court, which could have directed it to be filed even at the hearing. And whether this bill be regarded as a pure cross-bill, as an original bill in the nature of a cross-bill, or as an original bill, there is no error calling for the disturbance of the decree because the court proceeded upon it in connection with the other pleadings. The jurisdiction of the circuit court did not depend upon the citizenship of the parties, but on the subject-matter of the litigation. The property was in the actual possession of that court, and this drew to it the right to decide upon the conflicting claims to its ultimate possession and control. Minnesota Co. v. St. Paul Co., 2 Wall. 609; Bank v. Calhoun, 102 U.S. 256; Krippendorf v. Hyde, 110 U.S. 276, 4 Sup. Ct. Rep. 27. The decree of the circuit court is affirmed.