United States Trust Company of New York v. Wabash W. Railway Company/Opinion of the Court

Stripped of its complications, this case involves to a certain extent the same question disposed of by this court in Railroad Co. v. Humphreys, 145 U.S. 82, 12 Sup. Ct. Rep. 787, namely, whether the receivers of the Wabash system took possession of the leased lines under such circumstances as to charge them with the payment of the agreed rental so long as they retained possession of the lines.

The general rule applicable to this class of cases is undisputed that an assignee or receiver is not bound to adopt the contracts, accept the leases, or otherwise step into the shoes of his assignor, if, in his opinion, it would be unprofitable or undesirable to do so; and he is entitled to a reasonable time to elect whether to adopt or repudiate such contracts. If he elect to adopt a lease, the receiver becomes vested with the title to the leasehold interest, and a privity of estate is thereby created between the lessor and the receiver, by which the latter beocmes liable upon the covenant to pay rent. Sparhawk v. Yerkes, 142 U.S. 1, 13, 12 Sup. Ct. Rep. 104; Oil Co. v. Wilson, 142 U.S. 313, 322, 12 Sup. Ct. Rep. 235; Woodruff v. Railway Co., 93 N. Y. 609; In re Otis, 101 N. Y. 580, 585, 5 N. E. Rep. 571.

In this case, however, we are bound to consider the somewhat peculiar circumstances under which the receivers took possession of and operated the branch lines of the Wabash system. The bill was not an ordinary bill of foreclosure, but a bill filed by the mortgagor corporation for the purpose of preventing the disruption of the system, and securing a winding up of the old corporation and the organization of a new one, to which the various properties of the road should be transferred. The bill, which was certainly one of unusual character, purported to be filed not only for the benefit and in the interest of the mortgagor and the mortgagee, but also in the interest of the large number of branch corporations which were operated under one general management, and were a part and parcel of the Wabash system. Indeed, the bill expressly averred that defaults in the payment of interest were anticipated, and as soon as they should occur a number of suits would be commenced for the appointment of receivers under the original sectional mortgagees executed by the leased corporations; that under the terms of such leases the lessor companies would declare a forfeiture of the rights of the complainant; that its road would be broken into fragments, and would ultimately be sold in small sections, and a re-establishment of its unity rendered impossible.

This court has already held-Railroad Co. v. Humphreys, 145 U.S. 82, 101, 12 Sup. Ct. Rep. 787-that, after the appointment of receivers made in pursuance of the prayer of this bill, 'the court did not bind itself or its receivers, [to pay the agreed rentals of a leased line,] eo instanti, by the mere act of taking possession. Reasonable time necessarily had to be taken to ascertain the situation of affairs. The Quincy Company [and the same remark may be made of the Omaha Division] as a quasi public corporation, operating a public highway, was under a public duty to keep up and maintain its railroad as a going concern, as was the Wabash Company under the contract between them; but the latter had become unable to perform the public services for which it had been endowed with its faculties and franchises, and which it had assumed to discharge as between it and the other company. Its operation could only be continued under the receivers, whose action in that respect cannot be adjudged to have been dictated by the idea of keeping the property in order to sell it, or using it to the advantage of the creditors, or doing otherwise than 'abstain from trying to get rid of the property." On May 27, 1884, Humphreys and Tutt were appointed receivers of the property, and were directed to pay certain preferred claims, including rentals accrued, or which might thereafter accrue, upon leased lines. On June 26th the receivers reported to the court that, from the incoming rents and profits of the property, they were unable to pay on June 1st the interest falling due upon certain divisional bonds, and prayed the advice of the court as to paying the interest on these bonds, and as to how they should dispose of the earnings of the other lines or divisions which had not and would not for the present be enough to pay the operating expenses, the cost of maintenance, and the interest upon the bonds. This petition was referred to a master, who made a report on June 28th, upon which an order of court was entered that the receivers, 'from the incoming rents and profits of said property, after meeting such other obligations as they have been directed to discharge by the former order of this court, pay from whatever balance may remain in their hands the interest, as the same may from time to time mature upon the following bonds,' including those of the Omaha Division.

If this order of June 28th had been, as the court below seems at first to have construed it, (Central Trust Co. v. Wabash, etc., Ry. Co., 34 Fed. Rep. 259, 266,) as 'couched in such language that the intervener had a right to rely upon it, and expect the payment of his rent, until some other order was made,' there would be strong reason for saying that the receivers would be obligated to pay this interest as it matured. But upon a more careful examination of this order, upon a rehearing, the court came to the conclusion that it was not an absolute order to pay, but only an order to pay after the preferential debts had been discharged. 38 Fed. Rep. 63. We have no doubt of the correctness of this conclusion. The language of the order was that the receivers, 'from the incoming rents and profits of said property, after meeting such other obligations as they have been directed to discharge by the former order of this court, pay from whatever balance may remain in their hands.' The other obligations they had been directed to discharge were fixed by the order of their appointment of May 27th, as traffic balances, rentals accrued or to accrue upon leased lines, and for the use of terminal facilities and rolling stock, claims for labor, supplies, professional services, and salaries, maturing within six months before making the order, and current expenses for the operation of the road. It is true, as argued by the interveners, that among the preferred claims mentioned in this order were the rentals due and to become due on leased lines, and that there was no order of payment or relative rank fixed between the preferred claims themselves, the court evidently supposing that the income of the road would be sufficient to pay all the preferred debts. It was impossible, however, for the court, in making the order of June 28th, to have contemplated that the rental due the Omaha Division should be a preferred claim, inasmuch as the whole object of the order of June 28th was to provide for the payment of the interest due upon the bonds of this division after the payment of preferred claims. There is an apparent incongruity between the two orders, but we think it clear that the object of the order of June 28th was, as stated, to pay only from the balance after the payment of the preferred claims, not including as a preferred claim the claim for rental.

The owners of the leased lines were fully apprised by this order of the fact that payment of interest upon their bonds was conditional upon such balance existing; and the fact was that, after paying the operating expenses of the lines and the labor and supply debts of the Wabash Company, there was never a balance in the hands of the receivers out of which they could pay either interest or rentals. In fact, the preferential indebtedness which the receivers were by the order of May 27th directed to pay amounted to over $4,000,000, and the total gross earnings of all the lines of the system, from the day the receivers were appointed to the time the Omaha Division was surrendered to its trustee, lacked over $2,000,000 of being sufficient to pay the operating expenses and the labor and supply debts of the Wabash Company. The receivers did in fact pay the agreed rental of the Omaha Division up to October 1, 1884, to the amount of $82,250. Now, if the owners of the Omaha branch or the trustees of its mortgage, knowing, as they did, that system of which their road was a part had gone into the hands of receivers, and was being operated by them, had desired to repossess themselves of their property, or to object to the order of June 28th, they should have intervened and asked the court to protect their interests. While they may not have been parties to this order directly, they were parties to the bill, and were bound to know that their property, in the hands of the receivers, would or might be affected by orders which the court would make in the course of the administration of the insolvent estate, and should have made themselves parties to the proceedings that their rights might be protected. As was said in Miltenberger v. Railway Co., 106 U.S. 286, 1 Sup. Ct. Rep. 140, of certain mortgage creditors who had intervened to claim that certain expenditures had been made by receivers without authority: 'It did not comport with the principles of equity for the appellants to lie by and see the court and the receiver dealing with the property in the manner now complained of, and content themselves with merely protesting generally, and disclaiming all interest under the receivership, and yet assert * *  * that the other property acquired by the receiver, and now alleged to have been acquired by him without authority, was subject to the lien of the first mortgage, and now claim the proceeds of all that property, without paying the debts incurred in acquiring it. A court of equity, however it might act on the question of original authority or discretion, if presented in season and under circumstances of good faith, will not visit upon innocent parties, dealing with a receiver within the authority of its orders, consequences which result from the inequitable negligence and supineness of a party to the suit, or of those represented by him.' So in Meyer v. Johnston, 53 Ala. 350, it is stated, inferentially at least, that whenever, in the course of a receivership, the court makes an order which the parties to the suit consider injurious to their interests, it is their duty to file a motion at once asking the court to cancel or modify it. See, also, Wallace v. Loomis, 97 U.S. 146; Post v. Dorr, 4 Edw. Ch. 426.

It is well understood that, in the foreclosure of railroad mortgages, it often becomes necessary to provide for the payment of preferred claims, and to postpone all rights of ordinary creditors, and even of mortgagees, to these preferred classes, and that this is sometimes done from the necessities of the case without notice to all who may be affected thereby.

Nor is this aspect of the case changed by the fact that the earnings on the Omaha Division had previously been sufficient to pay the operating expenses, cost of maintenance, and interest upon its bonds, and that the receivers thought and believed such earnings would be sufficient to pay the interest, as well as the preferred claims. Various things had occurred or might occur, such as failure of crops, injury from floods, or other disasters, to affect its earning capacity, and the trustees were bound to know that the insolvency of the entire system of which their road was a part could hardly fail to affect the value of their securities.

On March 20, 1885, the receivers filed another petition, stating that the earnings of many of the lines had not been sufficient to pay the operating expenses, interest on bonds, and the rentals contracted to be paid, among which lines was the Omaha Division, the expenses of which, not including any charge for rental, had exceeded its earnings by $5,288.64, and praying the court to make such orders with respect to the future operation of such lines and the payment of the respective rentals as should seem proper to the court. In response thereto, the court, on April 16th, ordered that subdivisional accounts should be kept separately; that, where any subdivision earned a surplus over expenses, the rental or subdivisional interest would be paid to the extent of the surplus. Where it earned no surplus, but simply operating expenses, no rent or subdivisional interest would be paid; and where not only was no surplus earned, but an actual deficiency existed, operating expenses would be reduced to a minimum. At the time this order was granted there was some conversation between counsel in which it was said to be the wish of the receivers not to include in this proceeding the Omaha Division; but it was qualified by the express statement of the receivers that they did not wish to be understood as promising the bondholders the payment of the interest on the bonds within a short period of time under the circumstances.

The order was certainly notice to the branch lines that they must not expect payment of their rental where the subdivision earned nothing beyond operating expenses. The trust company; however, did not at this time see fit to intervene and demand possession of the property, but upon default in the payment of the interest due April 1, 1885, filed a bill of foreclosure in the state court, making the receivers parties to the bill. This suit was removed, upon petition of the receivers, to the circuit court of the United States. It was not until December 2d that the trust company petitioned the court for the surrender of the property. Under these circumstances, we do not think the receivers are chargeable with the unpaid rent. It is possible that the trust company acted under a misapprehension of its rights, but it is more probable that they expected the earnings of the road would be sufficient to entitle them to their interest under the orders of June 28th and April 16th. There appears to have been no good reason why demand was not made long before for the surrender of the property. It is true the receivers filed in the state court an answer, consisting of a single sentence, denying generally the allegations of the bill, and, in November following, they removed the case to the circuit court of the United States; but there was nothing in all this to prevent the trust company from applying to the United States court for possession of the property.

There is another reason, however, why the trust company is not entitled to the rental of this property prior to demanding possession thereof in its bill of foreclosure. The petition avers that, by reason of the defaults in the payment of the rentals, the receivers 'are indebted to your petitioner for the use and occupation of the said demised premises under the said lease.' But the mortgage or deed of trust to the trust company, the petitioner, did not purport to convey any of the incomes or earnings of the road, but provided that, if default should at any time occur in the payment of interest, the trustee should, when requested so to do, take possession of the mortgaged property, and operate the same, and collect and receive all the tolls and income thereof. It was also provided that, until such default, the mortgagors should be entitled to have and to hold the possession of the railroad, and collect, receive, and retain all the revenues arising from its use.

There was also a guaranty mortgage executed by the Council Bluffs & St. Louis Railroad Company to the same trustee, conveying all its right, title, interest, and estate in the demised premises, with all the mortgagor's rights, privileges, and franchises, acquired or to be acquired, subject only to the lease. Now, if the mortgage had covered the earnings and rentals of the property, and those had constituted a part of the estate conveyed to the trust company as security for the bonds, there would be some reason for saying that it would be entitled to recover these earnings and rentals in this action before it demanded possession of the road. But where the mortgage provides that the mortgagor shall remain in possession until default, but, when default occurs, the trustee may enter, this court has held that the trustee can only secure the earnings of the mortgaged property by taking or demanding possession. And in Railway Co. v. Cowdrey, 11 Wall. 459, 483, it was held that even where the mortgage covered the tolls, income, and profits of the railroad whenever the company should be in default of payment, but a subsequent clause provided that, in case the company should be in default in payments of principal or interest for three months, the trustees should take possession of the road, and collect and receive the tolls, income, and profits, etc., until regular demand was made for the payment of tolls and income, the defendants were not bound to account therefor. So in Gilman v. Telegraph Co., 91 U.S. 603, the trustee in a mortgage, which covered a road with its revenues and incomes, sought to recover as against a general creditor a fund that had been earned before the trustee took possession of the mortgaged property. The deed of trust in that case provided that, if default occurred in the payment of interest, the trustee might take possession, and receive the income and earnings of the road, and apply them to the debt secured. The court held that the trustees had no claim upon the fund. In delivering the opinion of the court, Mr. Justice Swayne observed: 'It is clearly implied in these mortgages that the railroad company should hold possession and receive the earnings until the mortgagee should take possession, or the proper judicial authority should interpose. Possession draws after it the right to receive and apply the income. * *  * In this condition of things, the whole fund belonged to the company, and was subject to its control. It was therefore liable to the creditors of the company as if the mortgages did not exist. They in no wise affected it. If the mortgagees were not satisfied, they had the remedy in their own hands, and could at any moment invoke the aid of the law or interpose themselves without it.'

In Bridge Co. v. Heidelbach, 94 U.S. 798, the mortgage included the rents, issues, and profits of a certain bridge, in so far as the same were not necessary to pay its operating expenses and the cost of keeping it in repair. The question in the case was whether earnings that had accrued from the use of the bridge before the bill of foreclosure was filed by the trustees were covered by the mortgage, and prevailed over the rights of a judgment creditor. In this case it was said that 'the mortgage could have no retrospective effect as to previous income and earnings. The bill of the trustees does not affect the rights of the parties. It is an attempt to extend the mortgage to what it cannot be made to reach. Such a proceeding does not create any new right. It can only enforce those which exist already.'

There are a number of other cases in this court to the same effect. Kountze v. Hotel Co., 107 U.S. 392, 2 Sup. Ct. Rep. 911; Trust Co. v. Shepherd, 127 U.S. 494, 8 Sup. Ct. Rep. 1250; Sage v. Railroad Co., 125 U.S. 361, 8 Sup. Ct. Rep. 887; Dow v. Railroad Co., 124 U.S. 652, 8 Sup. Ct. Rep. 673; Teal v. Walker, 111 U.S. 242, 4 Sup. Ct. Rep. 420.

The substance of these rulings is that until the mortgagee asserts his rights under the mortgage to the possession of the road by filing a bill of foreclosure, or, if the road be in the hands of a third party, by demanding possession of such party, he has no right to its earnings and profits. In other words, there is no privity of contract or of estate between the mortgagee and lessee, at least until the mortgagee has taken possession of the property, and become the assignee of the rights of the mortgagor.

On December 2, 1885, the trust company made formal application to the court for the transfer and surrender of the Omaha Division to a receiver to be appointed in the suits then pending for the foreclosure of the mortgage. The motion was called to the attention of the court on December 8th, and was opposed by counsel for the Central Trust Company of New York, the trustee of the Wabash general mortgage, upon the ground that the application should be postponed until January 4, 1886, when the decree in the Wabash suit would be presented to the court for settlement, and the matter of this petition, as well as all other questions, could be presented and passed upon. This application for the postponement was resisted by the counsel for the United States Trust Company, but was granted by the court, which expressed an unwillingness to permit the further disintegration of the system. No order was made at this time with respect to the rental. Upon the renewal of the application, on January 6th, the court ordered a surrender to be made within 30 days, with an option to the Wabash receivers to retain the division for an additional 30 days, on the payment of 1 month's rent, namely, $13,708.33. The receivers availed themselves of this option, and paid the rent, with the hope that during that time some arrangement might be made to keep the line within the system, so that the surrender did not actually take place until March, 1886. As the rent for the last 30 days was paid, the sole remaining questions are as to the rent from December 9th to February 6th.

The master to whom the case was referred reported that the trust company was entitled to the two-months rental, at $13,708.33 per month. But the court, upon hearing exceptions to such report, was of the opinion that while the receivers were liable for the first month's rental, namely, from December 7th to January 6th, upon the ground that the delay upon the consideration of the motion was opposed by the counsel of the trust company, the further delay of 30 days was with their consent; hence that they were equitably estopped from claiming rental for the second month.

We agree with the court below in this conclusion. When the motion was called up, on December 6th, the trust company insisted upon its right to have an immediate surrender of the road, and opposed even a postponement of 30 days. Possession of the road being withheld from them without their assent, they are equitably entitled to rent for this month. But the order entered on January 6th, directing the receivers, at the expiration of 30 days from that date, to surrender possession to a receiver to be appointed by the United States circuit court, having been entered by consent of the parties,-in other words, the trust company having waived the delivery of the road for 30 days,-it ought not now insist upon payment for that period. Indeed, as the receiver of the Omaha Division had not then been appointed, it is difficult to see to whom the road could have been immediately turned over.

As bearing upon the general equities of the case, it may be remarked that, while the proceedings in the foreclosure of the Wabash mortgage did undoubtedly result in the detention of the road from its lawful owners for about 15 months without the payment of the agreed rent, the road during this time earned nothing beyond its operating expenses, and there is nothing to indicate that it would have done so in the hands of its owners; so that, in fact, they lost nothing. Indeed, it is scarcely credible that they would have delayed so long to demand possession of the road if, in their opinion, it could have been operated at a profit.

The decree of the court below is therefore affirmed.