St. John v. Erie Railway Company/Opinion of the Court

'The association is required to deposit. . . stocks of the State of New York.'

'Now when the capital of the bank is required to be invested in stocks, and among others in United States stock.'

The court is here speaking of State debts and United States debts.

The statutes of the United States equally use the terms debt and stock as convertible. One of them, ex. gr., relating to a 3 per cent. loan, says:

'Any part of the principal of the said debt or stock, bearing an interest of 3 per cent., as shall be unredeemed, shall,' &c.

Then the use of the word 'stock' is nothing, and the only question is, does the contract, as expressed, mean what we assert that it does mean?

In settling that meaning it is to be noted that these preferred stockholders never sustained the ordinary relations of stockholders, general or preferred. They began as creditors. They never subscribed for stock, nor paid instalments, nor took part in creating a corporation, nor had an opportunity to share in unlimited profits, nor agreed to assume any of the ordinary risk of stockholders, nor bargained for so large a vote as to be able to protect themselves, but from the beginning relied on a peculiar contract relation, due notice of which they caused to be conspicuously published to all the world. They are in part creditors and in part stockholders, and not technically either. They have the rights which their contract gives them, and a name will not make those rights greater or less. Modern business and legislation have created relations which, according to the narrow views of the old laws and decisions, would be anomalous, and in them a person may be in some sense and at the same time a creditor and a stockholder. Such is the case of every preferred stockholder.

There is no use of considering what would be our condition in case of insolvency, and who would be then preferred. What has that condition to do with our rights during solvency? We will consider the case of insolvency when it arises.

It is matter of common knowledge that the Erie Railway has been largely built by English capital. The agreement whose meaning is now under consideration was doubtless made in all its parts by representatives of English capitalists. The expressions of English statutes, the views of English writers, and the decisions of the English courts may be looked to with more than common deference in interpreting it. Now, in the English law, preferred stock is commonly called debenture stock, the word debenture coming obviously from debere, to owe. So the dividends on preferred or debenture stock are commonly called interest; and the English law declares them to 'rank next to interest payable on the mortgages or bonds for the time being,' though it admits of course that the holders of it cannot require repayment of what they have paid for it.

Nor is there anything in the use of the word 'dividend' which of itself impairs our argument. If it was said, in terms, that the 'dividend' on preferred stock was to be paid out of net earnings from existing roads, and next after mortgage-interest, and prior to rent on any new leases, and prior to interest on any new loans, the meaning and the case would be clear. The word 'dividend' then is unimportant. And the only question is whether, in any way, the meaning and the case are clear? This so-called dividend, it will be noted, is to be declared from 'net earnings,' and is payable absolutely, each year, if earned, immediately after the mortgage-interest is paid. The payment may be called a dividend, but it is more analogous to interest.

If every common stockholder should be present and vote to have any such surplus of net profits used for some other designated purpose, this would confessedly not impair the claims of preferred stockholders to receive it.

In the case of Maryland v. Railroad Company, very lately decided by this court, the State of Maryland was, by a contract with the Baltimore and Ohio Railroad Company, entitled to have and receive a perpetual dividend of six per cent. per annum (upon $3,000,000 which the State lent to the company), out of the profits of the road. Does any one doubt that this made a debt from the company to the State in case any profits were made? And that calling the money to be paid a dividend was nothing?

Nor is there anything in the expression 'net earnings' which impairs our argument. Of course 'net earnings' are gross earnings after the deduction of every sort of cost, charge, and expense of administering and working 'the road.' But what road? That is the question to be settled. The language is 'the net earnings of the said road.' Does 'the said road' mean the road then known as the road of the Erie Railway Company-the road, and the only road, which had been before the contracting parties-with its then leased roads,-or does it mean that road-that 'said road'-with a score of different, distant, and most unprofitable roads, worked into its corpus as a part of it, and with $5,000,000 of debt created to equip and use them? That, we say, is the question.

The case made by the pleadings is a little obscure as to what road or roads absorbed the $5,000,000 borrowed. But that vast sum is not shown to have been expended on the line as it existed when the preferred stock was created. That line must have been completed and equipped, and it could never have been expected that such sums would be borrowed to use on such a road. Without doubt the money was expended in great measure on the newly leased lines.

II. Now, the defendant should have kept separate accounts of its newly leased roads, and been prepared to sustain their losses or demonstrate their profits. The plaintiff is entitled to have counted as gross earnings on the line as it existed when his stock was created, all the money thereon received and earned, and from this can be deducted only the expenses of operating such line, including, of course, rents payable for any portion of it. Such accounts are easily kept. On that basis the plaintiff will take his chances of a dividend, as the contract provides, and will regard his prospects as greatly improved. The company denies that right, and refuses such account and payment. This rule of separate accounts is the English rule. In Corry v. Londonderry, where there were five classes of stockholders, the court held that the company must keep separate accounts, and that the discretion of the directors over expenditures was limited by the rights conferred on preferred shareholders. Where net profits were pledged, as here, it was held they could not be diminished by subtracting from them 'money raised under the borrowing powers,' and that 'money procured for the purpose of completing the line cannot be paid out of profits.'

A material part of the reasoning of this case has been sustained by Taft v. The Hartford Railroad, in this country.

III. It will be said, doubtless, by opposing counsel, that our view of the law would obstruct all expansion of the company's business, by preventing the company borrowing money or leasing roads. If such was the effect, the fact would be no reason for the court refusing us our right. Such a contract made by the company, and sanctioned by the courts and the legislature, as this has been, would be valid, however inconvenient it might be. But such is not the effect. The company may lease, and borrow, and expand, and the preferred stock no more obstructs them than does a mortgage. They must first give us a dividend, if there be net earnings to pay it, just as they must pay mortgage-interest.

Mr. W. W. McFarland, contra, for the company.

Mr. Justice SWAYNE delivered the opinion of the court.

The question presented in the present case depends for its solution wholly upon the construction given to the fifth clause of the agreement of 1859, and the fourth section of the act of 1861. They are identical in effect as regards the point to be considered.

The original takers of the preferred stock were creditors. They abandoned that position and became stockholders. They thereupon ceased to be the former, and can only be regarded as the latter. They surrendered their debts and received in return stock of the same amount, which gave them a chance for annual dividends of seven per cent., and a voice by voting in the choice of those by whom the affairs of the company were to be administered. What they were to receive was not interest, but dividends; and they were to receive them in priority to the holders of the common stock. The latter could receive nothing until the former were satisfied. The maximum payable on the preferred stock was specified. It might be less, or nothing. It could not be more. The amount subject to the limit prescribed depended wholly upon the residue of the net earnings applicable in that way. The language employed is apt to express the relation of stockholders. None to express the relation of creditors is found in the instrument; and there is nothing from which the intent to continue that relation any longer can be inferred. If the mortgages were foreclosed and there were a surplus left insufficient to satisfy the general creditors, it is quite clear that the holders of the preferred stock could have no right to share in the fund.

The dividends were to be paid after the mortgage-interest and delayed coupons were paid in full.

This clause was inserted doubtless out of abundant caution, to prevent the possibility of a claim being set up to the prejudice of the holders of the mortgage securities. Whether the restriction was necessary, for that purpose, we need not consider. The preferred dividends were to be paid out of 'the net earnings of the road.' The lexical definition of net is 'clear of all charges and deductions.'-Webster. 'That which remains after the deduction of all charges or outlay, as net profit.'-Worcester. The popular acceptation of the term is the same. There is no controversy between the parties on this subject. Such net earnings must have been earned in 'the current year.' There are these four specific limitations. There are no others. It is not said that the preferred dividends shall be paid next after the mortgage interest and delayed coupons, nor after, nor pro rata with anything else, nor before anything else except dividends upon the common stock. Beyond the four restrictions named, the matter is left to be regulated wholly by the principles of law and the discretion of the company. Suppose in this case the holders of coupons of the sterling bonds and the holders of preferred stock claimed payment at the same time and the fund was insufficient to meet both demands, can it be doubted that the rights of the creditor would be held paramount to those of the shareholder, and that the interest must be fully satisfied before a dividend could be paid? The plainest principles of reason and justice as well as the law would require this result. A question is raised as to the source to which the phrase 'net earnings of the road' refers. The term road is used as an appellative, and was clearly intended to include the principal road and all its adjuncts. The complainant insists that the net earnings must be the net earnings of things as they were when the preferred stock was issued. We find nothing in the case, express or implied, to warrant this view. At the time referred to, the company held certain leases. If it was deemed best, and was found practicable, could not the company have rid itself of them? If the complainant's view be correct, this could not be done, at any rate not without the consent of the preferred stockholders. So if the company deemed it proper to take leases of other roads, in addition to those previously held, or in place of them, what was there to prevent it? Upon what ground can it be claimed that the category 'net earnings of the road' was not intended to embrace the net earnings of all the business of the company for the time being, whether done upon one or many roads?

There is nothing in the agreement or the statute, and we are aware of no legal principle which would authorize the stockholders in question to analyze the business, select out a part of it, and to say that the net earnings specified must be a predicate of that part, and of none other. The company had the right to conduct its operations, in good faith, as it might see fit; and it was from them and all of them that the materials for the computations of earnings were to be derived.

The only qualification prescribed in this connection is not as to the scope, means, or elements of the business, but is one in point of time. The net earnings from which the preferred dividends were to be paid must have been earned 'in the current year.' Whether the business of such year were large or small, or of what it consisted, is immaterial. The corporation never agreed to be limited in the exercise of its faculties and franchises, and the complainant must abide the result. If errors wee committed, and a loss ensued, a court of equity cannot relieve him. It is one of the chances of the enterprise in which he embarked.

The business of the road was a unit. If it had been diaintegrated as proposed by the complainant, we apprehend it would have been found that the correlations of the main stem and the branches were such, and that the expenses and charges incident to the entire business and those of the several parts were so interwoven and blended, that an accurate ascertainment of the net profit of the main line and any of the auxiliaries, taken separately from the rest, would have been impracticable. An ancillary road may be short and yield but little income, yet by reason of its reaching to coalfields, or from other local causes, its contributions to other roads of the series may be very large and profitable. Whether in this case the partial computation insisted upon could or could not have been made, the process was one upon which the company was neither bound nor had the right to enter.

We hold that the computation by the company for the year 1868 was made upon the proper basis, and that the complainant is concluded by it. We are of the opinion that the rents for that year, accruing under leases taken by the company after the issuing of the preferred stock, and the interest upon the sterling bonds for that year were properly paid, and that there were no net earnings earned in that year which could be properly applied in payment of preferred dividends. These views are fatal to the complainant's case. We have carefully examined all the authorities referred to by his learned counsel. None of them are in hostility to the conclusions at which we have arrived.

DECREE AFFIRMED.