American Brake Shoe & Foundry Co. v. Pere Marquette R.

205 F. 14, 123 C.C.A. 322, 1913 U.S. App. LEXIS 1407

Opinion

KNAPPEN, Circuit Judge

(after stating the facts as above). [1] 1. The bill in the suit in which the receivers were appointed and the order in question made was filed by a single creditor, who had no judgment and claimed no lien, and who thus had no standing (except by ■consent of the defendant) to seize the latter’s property and apply it to the satisfaction of complainant’s claim. None of those representing the mortgage interests were made parties. The suit is criticised as in effect that of the railroad company and for the benefit of its stockholding interests. But the objection that the bill was filed by a single unsecured creditor, without judgment or claim of lien, is waived, and stands as though it had never existed, when the defendant voluntarily appears, confesses the debt, admits its insolvency, and joins in the prayer for receivership. Such objection cannot, therefore, be raised by other creditors, who were not parties to the suit as brought; and the case will not- be regarded as collusive merely because the parties to the suit acted in accord and arranged together that the suit should be brought in a given court, and that the averments of the bill should be admitted by the answer. In re Metropolitan Railway Receivership, 208 U. S. 90, 110, 28 Sup. Ct. 219, 52 L. Ed. 403; Horn v. Pere Marquette R. R. Co. (C. C.) 151 Fed. 626, 633. We have nó doubt of the-court’s jurisdiction to entertain the creditors’ suit and to appoint receivers therein.

[2] Nor is there any doubt of the power of a court of equity; in a proper case, through its receivers (which constitute the hand of the court), to borrow money necessary for conserving the property and •continuing its operation, pending foreclosure, reorganization, or other appropriate disposition. A railroad company owes a duty, not only to its creditors and stockholders, but, by virtue of its franchise, to the public as well; and a court which has undertaken the administration of railroad affairs is charged with the duty of conserving and operating the property, so far as can practically be done, for the benefit of both public and private interests. Jn the exercise of this duty of conservation and operation, it may, in a proper case, make such repairs, replacements, and betterments as are purely essential to such results, and may, in a proper case, make the certificates for such loans a lien even upon the corpus of the properly, and, so far as necessary, prior to existing liens. The authority, however, to disturb existing liens, should be exercised with great caution, and should be carried no further than actually necessary to attain the desired result. Wallace v. Loomis, 97 U. S. 146, 152, 162, 24 L. Ed. 895; Miltenberger v. Railroad Co., 106 U. S. 286, 309, 1 Sup. Ct. 140, 27 L. Ed. 117; Trust Co. v. Illinois Midland R. R. Co., 117 U. S. 434, 6 Sup. Ct. 809, 29 L. Ed. 963; Atlantic Trust Co. v. Chapman, 208 U. S. 360, 371, 28 Sup. Ct. 406, 52 L. Ed. 528, 13 Ann. Cas. 1155. While this power has been more often exercised in mortgage foreclosure cases, it is not limited thereto, but may be exercised in creditors’ suits such as the one before us. Union Trust Co. v. Illinois Midland R. R. Co., supra, 117 U. S. 458, 6 Sup. Ct. 809, 29 L. Ed. 963. Disbursements of the nature of those here in question may, in a proper case, constitute expenses of conservation. Wallace v. Loomis, supra; Union Trust Co. v. Illinois Midland R. R. Co., supra.

[31 It is not necessary to the exercise of this power that the security holders whose liens are postponed be, by the bill, made defendants or otherwise brought in as parties to the creditors’ suit. Of course, no order finally affecting- liens should be made without giving to the holder of the affected lien adequate opportunity to be heard. But it is not fatal to Lhe validity of the order before us that appellant was not heard before the order originally passed, ft is sufficient ill at it was given opportunity to be heard before the order became practically effective. Union Trust Co. v. Illinois Midland R. R. Co., supra, 117 U. S. 459, 6 Sup. Ct. 809, 29 L. Ed. 963. The opportunity so given was full and adequate. The interests of no other lienholder are injuriously affected by the order made. There is thtis no lack of proper parties. The crucial questions are those of fact: First, whether the circumstances necessitated (for the purpose of conserving and operating the railroad property) the borrowing of money for making the purchases and payments provided by the order; and, second, securing the money so borrowed in the way so provided.

[ 4 j 2. We think the District Court did not exceed the limits of a proper discretion in authorizing the borrowing- of $1,700,000, made up as follows: For new rail, $525.000; for new equipment, $775,000; three new engine houses, $150.000; three coaling plants, $100,000; two yards, $100,000; three new depots, $50,000. Judge Sessions well said :

-‘If it is necessary to the existence of this railroad that it have new equipment, and. that betterments be added in order that it may serve the public, and. in order that it may be permitted to continue to exist as a railroad, and in order that it may preserve its integrity and its usefulness as a railroad, then the court has the power to provide, a way for the performance of that duty.”

We construe Judge Sessions’ opinion as holding that the equipment and betterments mentioned were necessary for .the purposes just stated. While- Judge Angelí filed no opinion, we think we have the right to infer from the terms of his order that he held a like view. The concurring views of these two judges should not be lightly disturbed. We think the record sustains that view. The new rail was not- to be used for extensions, but to replace lighter and worn-out rail in various parts of the system in Michigan (except some on the Indiana line), without reference to the existence of mortgage liens. Judge Sessions said (and we think rightly):

“The purchase of the new rails and the reconstructing of a portion of the line of the road is nothing more than the repairing of the road.”

The new equipment was in large part' to take the place of worn out and old equipment. There was shown to be crying need both of the new equipment, the engine houses, coaling plants, and additional yard room. Two of the engine houses were to supply the place of practically useless structures; the third to take the place of one occupied jointly with another road, with stalls too short and table too light for the modern engine, and so located that incoming and outgoing, engines must cross the tracks of other companies, causing considerable delays. One of the coaling plants to be replaced was “about ready to fall on account of decay”; another was to take the place of a plant lately burned and where locomotives and trains are now coaled practically by hand— a witness stating that on one winter morning he counted 36 engines waiting for coal, and, according to his recollection, 20 of them frozen up. We understand that the two new yards are merely extensions of present yards, and that the extensions are needed, to overcome serious congestion. While the need of new depots is perhaps not shown to be as urgent as in the case of the other proposed structures, they were apparently regarded by the court as immediately necessary and for the conservation and proper operation of the system. Judge Sessions well said, that:

“The depriving of a road of immediate and necessary improvements, such as station houses, such as roadbeds, is simply another way of dissipating and destroying the value of the road.”

The amount of this item is but $50,000.

We are also satisfied that the District Court did not exceed its discretion in authorizing the borrowing of $1,800,000 for paying the principal of equipment obligations maturing during the year ending April 30, 1913. The equipment was held under six separate trusts. The aggregate purchase price of the equipment upon which the principal payments were proposed to be made exceeded $14,000,000, of whicIT less' than $5,000,000 remained unpaid. Nearly three-quarters of the latter amount was secured upon equipment purchased but little more than two years previously. That purchased in earlier years, and presumably more greatly depreciated in value, was in larger propor lion paid for. On the oldest equipment (which cost over $5,500,000) but $650,000 remained unpaid, and that amount was to be entirely paid under the order in question. The payment of the $1,800,000 would leave unpaid but little over $3,000,000 principal, as against over $14,000,000 purchase price. This equipment was essential to the operation of the road. Its loss, through default in payment therefor, would seriously hamper, if not cripple, the road’s operation. Presumably its value was such as to justify complete payment.

it is true that the earnings were chargeable, in advance of interest on mortgages, with all the classes of items making up the $3,500,000 of certificates, and to the extent to which earnings were improperly diverted to interest payments borrowing would not be justified. It, however, it would have been proper to borrow money to pay the interest in question, no injustice has been done. Apart from the propriety of giving loans for interest payments priority over the lien of appellant’s mortgage, it was clearly proper to borrow money to pay the interest on the "divisional mortgages,” including the Indiana and Canadian lines; for default in such payment would naturally lead to foreclosure, with danger of dismemberment of the system, and the record is convincing that such dismemberment is against not only the public interests, but those of junior incumbrancers, including appellant.

3. The important question is whether conditions justified making the lien of the receivers’ certificates prior to that of appellant’s mortgage. The reason assigned for the priority given the lien of the certificates is that appellant’s mortgage is the first of the “system” mortgages, and that, as the expenditures concerned are for conserving the system, the lien thereunder should antedate appellant’s lien, and that if subordinate to the latter lien the certificates would not be salable. Broadly speaking, this plan of priorities seems justified. The expenditures for rail, new equipment, engine houses, coaling plants, yards, and depots increased the value of the system, and thus to an extent (although not to the full extent of the disbursements) increased the value of appellant’s lien. Moreover, the discharge of obligations for equipment on which appellant has a lien would normally increase its security. Again, it cannot well be complained that interest on the mortgages of the “constituent” companies (the three original divisions) is in fact borrowed, and so given a standing prior to appellant’s lien; for those mortgages being ahead of appellant’s, and their properties covered by the latter’s lien, it cannot sensibly prejudice appellant’s rights that the interest is paid and made a separate lien, rather than left in arrears and added to the principal lien.

The interest on the Indiana securities stands on a somewhat different basis, for appellant’s mortgage is not directly a lien upon the Indiana line. But, apart from the consideration of preventing dismemberment through default in Indiana interest, we think its payment works no injustice to appellant; for while the earnings of the Indiana mileage do not appear, and it is thus not affirmatively shown that its net earnings are such as to provide for interest charges, yet the court may judicially notice that the Indiana mileage is part of the important line between Grand Rapids and Chicago, necessary to the Chicago con nection, and presumably its value to the system is such as to warrant its retention to the extent of paying the small annual interest ($27,-000) upon its mortgage indebtedness.

In the nature of things, appellant is, at the best, bound under the general plan of the order to suffer some impairment of its lien. So far as such impairment is necessary to the conservation of the road, and the performance of its public and private duties, appellant must submit to the impairment. And such seems to be the situation with reference to the purchase of new equipment, rail, engine houses, coaling plants, yards, depots, interest on mortgages of constituent companies and on the Indiana mortgage, and the payment' of principal and interest on existing equipment obligations. But appellant should not be called upon to suffer impairment of security further than actually necessary for conservation and due operation of the system. We are disposed to think that in two respects the order unduly adds to appellant’s burden:

(a) It has no direct lien upon the Canadian lines. Interest upon the indebtedness charged on those lines is in practical effect to be borrowed, and the indebtedness, therefore, given priority over appellant’s security. Such interest is, therefore, to be paid to the ultimate prejudice of appellant, unless the net earnings of the Canadian lines available to the receivership provide therefor, and except to the extent that appellant is benefited by avoiding foreclosure on the Canadian lines. Appellees insist that these lines have net earnings available to fully meet interest charges, and that thus appellant is not injured. The margin of net profit from recent operations appears small, and the Canadian lines are being operated under a Canadian receivership; the money being disbursed only by order of the Canadian courts. Appellees say that “the order appealed from does not direct the Michigan receivers to pay the Canadian interest out of Michigan earnings,” and that “it cannot be assumed that these receivers will use this discretion by applying Michigan earnings to pay Canadian interest.” We are disposed to think that appellees should be taken at their word, and that the order should be so modified as to permit the payment of Canadian interest only out of net Canadian earnings.

(b) With respect to appellant’s lien on equipment: As to that already bought since the organization of the present company in 1907, and that to be bought through the medium of the receivers’ certificates, appellant is confronted with the legal question (upon which we express no opinion) whether the lien of its mortgage, under the after-acquired property clause, is prior to the lien of the securities given by the present company. The order makes the certificates a first lien upon all the new equipment purchased, as well as on the $650,000 of equipment obligations entirely discharged (in case the same shall be acquired by or for the receivers), and “through such obligations an ultimate first lien on all the equipment which now directly or indirectly secures such obligations,” as well as on any other equipment obligations acquired by the receivers representing principal equipment payments authorized to be met. Moreover, as to the equipment released by the payment of existing equipment obligations, the order not only provides for making the certificates an ultimate first lien thereon but authorizes a trust agreement under which the title to and ownership of all such new equipment, and the .ownership of all said equipment obligations, shall rest, hi such trustee, for the benefit, not only of certificate holders, but “of any future securities, issued in pursuance of any plan of reorganization, for the refunding of such certificates in whole or in part.” The complaint that certificates are to he issued in part for purchase of equipment (or the payment of obligations therefor) on which appellant’s mortgage may not become an effective lien, is not, we think, fatal to the order. Appellant asserts the priority of its lien over that of subsequent mortgages, and tlie necessity of the equipment for preserving the integrity of the railroad property is apparent. But we see no reason to provide now for reorganization possibilities; and, in order to avoid, so far as possible, any foreclosing of or prejudice to appellant’s rights, we think the order should contain an express provision that nothing contained in it shall impair atiy otherwise existing right in appellant to be subrogated to the lien of the certificates upon both classes of equipment, old and new, to the extent that such equipment may not be subjected to or be sufficient for the payment of the certificates, nor shall it create any new priority, save the lien of the certificates themselves, as against the lien of appellant’s mortgage, in so far as it may by law attach to the equipment.

4. Appellant complains of the direction to the receivers to pay the interest on appellant’s mortgage, as tying its hands by preventing foreclosure, thus precluding relief from a burdensome situation. Under ordinary conditions, appellant could not be heard to complain of the payment of interest to itself, and thus of a prevention of a default which would give right of foreclosure. Lloyd v. C. & O. S. W. Ry. Co. (C. C.) 65 Fed. 351, 356. But the situation here is a peculiar one. The order in question was made nearly a year ago. The estimated net income from operation for the then ensuing year, in view of which the order in question was made, added to the amount expected to be realized from the certificates, hid fair to lack several hundred thousand dollars of meeting the payments contemplated during the ensuing year, including interest on underlying mortgages, principal and interest on equipment obligations, new equipment purchases, the making of betterments and the meeting of current, matured obligations; and this without providing for the payment of the principal of more than $4,-000,000 of receiver’s certificates, unmatured equipment obligations (maturing, in part, from year to year thereafter) of more than $3,000,-000, besides at least $5,000,000 of debentures maturing July 1, 1912, to say nothing of more than $1,200,000 of interest on junior incumbrances.

If, as seemed not unlikely when the order was made, an indefinite continuance of the receivership is to result in a constantly increasing indebtedness prior to appellant’s mortgage, appellant can, we think equitably complain of tlie denial of opportunity to foreclose. The record does not advise us of the salable value of the railroad property. But, to say the least, it may well be that further considerable increase of indebtedness prior to appellant’s mortgage will seriously impair, if not destroy, its value. The object of a creditors’ suit is not to permanently or Indefinitely tie up the property, but merely to conserve and operate it pending ultimate disposition, to marshal its assets, and in some suitable manner to devote them to the payment or security, of its indebtedness. We are not advised of the receiver’s plans for the coming year, nor should we attempt to forestall the exercise of discretion by the District Court. Under the circumstances, we content ourselves with suggesting that our action upon the present order must not be taken as indorsing, the propriety of further increasing the indebtedness prior to appellant’s mortgage in injury to that security, without leaving appellant free to protect itself by foreclosure. Should that question later arise, it can then be determined.

The order appealed from should be modified as suggested in subdivisions (a) and (b) of paragraph 3 of this opinion. In other respects, it is affirmed. The costs of the appeal will be divided.