New York Trust Co. v. Carpenter

250 F. 668, 163 C.C.A. 14, 1 A.F.T.R. (P-H) 954, 1918 U.S. App. LEXIS 1950

• Court: Court of Appeals for the Sixth Circuit
• Decided: May 7, 1918
• Docket: No. 3112
• Status: Published

Opinion

HOLLISTER, District Judge

(after stating the facts as above). [1] The motion to dismiss the appeal will be overruled, for the reasons that the receiver has not been discharged; he is still prosecuting claims in behalf of the Wheeling, recovery on which will be assets in his hands; and the deficiency judgment obtained by the New York Trust Company, as trustee for the noteholders, has been by the plan of reorganization of the Wheeling expressly kept alive and has been assigned to the Wheeling’s successor and is one of its successor’s assets.

[2] The appellants, while denying that these bonds or the deficiency judgment on them are a debt of the Wheeling and a general claim against it, urge a number of reasons why they cannot be so recognized, even if they could otherwise be established. These reasons need not concern us now, because in our opinion there is no ground upon which to fasten these bonds or the deficiency judgment on the Wheeling as its obligation, either by contract, express or implied, or on principles of agency, or of estoppel, or by operation of law, or by reason of any finding of any court in the somewhat complicated litigation presented by these records.

The District Court in the Eirst Carpenter Case found:

“That the Pittsburgh, Wheeling & Lake Erie Coal Company was organized and at all times managed and controlled by the Wheeling & Lake Erie Railroad Company as an adjunct to or agency of said railroad company for the operation of the coal property owned by it.”

With this finding as a premise, the Coal Company’s bondholders claim, as an inevitable corollary, that their bonds are the obligation of the Wheeling as if it had executed them itself. They concede “that ownership by one corporation of all the stock of another does not of itself create-liability,” and “that the mere fact that one corporation controls the affairs of another does not of itself create liability,” but they say:

“That a court of equity will ignore corporate fiction in two classes of cases: First', where the holding company has created its subsidiary company in fraud of the rights of creditors; and, second, where the subsidiary company has been created simply as an adjunct or instrumentality of the holding company.”

They base this assertion and its consequences on language found in the opinion of the Circuit Court of Appeals in the Second Circuit in the case In re Watertown Paper Co., 169 Fed. 252, 256 (94 C. C. A. 528), wherein exceptions to the rule of a corporation’s separate and distinct entity are thus stated:

“(1) The legal fiction of distinct corporate existence will be disregarded, .when necessary to circumvent fraud. (2) It may also be disregarded in a case where a corporation is so organized and controlled, and its affairs are so conducted, as to make it merely an instrumentality or adjunct of another corporation.”

This language was quoted by the same court in Gay v. Hudson River Elec. Power Co., 187 Fed. 12, 14, 15, 109 C. C. A. 66, and was adopted in Hunter v. Baker Motor Vehicle Co., 225 Fed. 1006, 1015 (D. C.).

This court (Pittsburgh & Buffalo Co. v. Duncan, 232 Red. 584, 587, [146 C. C. A. 542]), in denying the claim that one of the corporations involved in that case -was liable for the debt of the other, said:

‘‘The mere fact that the stockholders in two or more corporations are the same, or that one corporation exercises a control over the other through ownership of its stock, or through identity of its stockholders, docs not make either the agent of the other, nor does it merge them into one, so as to make a contract of one corporation binding upon the other, whore each corporation Is separately organized tinder a distinct charter. * * * True, ¡.he legal fiction of distinct corporate existence will be disregarded when necessary to prevent fraud, or when a corporation is so organized and controlled and its affairs so conducted ‘as to make it only an adjunct or instrumentality of another corporation.’ ”

In re Watertown Paper Co., Gay v. Hudson River Elec. Power Co., and Foard v. Maryland, 219 Fed. 827, 829 (135 C. C. A. 497), were cited, and it was said further:

“ * * ‘It requires a strong case to induce a court of equity to consider two corporations as one, on account of one owning all the capital stock of the other.’ ”

The underlying reason for the decision was that no injustice was worked through the normal operation of corporate forms, or by according the corporation the separate entity which the law gives it; and the reference to the so-called second exception was rather a memorandum of decisions elsewhere on a question, cognate, but collateral only, to the point decided.

We do not think these decisions establish a hard and fast rule of law from which there is no escape, whatever the circumstances of the case under consideration, and without regard to the reasons upon, which any exception could properly be founded.

Of course, if a corporation is the agent of another, owning its stock or not, as the casemay be, through which the other as principal, disclosed or undisclosed, carries on business, the liability of the principal will be ascertained through principles of law well known and long established. But it is not claimed that the Coal Company was the Wheeling’s agent in this sense. It was not and could not be, because the bondholders with full knowledge dealt with the Wheeling as principal in the contribution contract, and with the Coal Company as principal in the execution of the botids. The District Court used the word “agency” as a synonym of “adjunct,” whatever that may mean, and as descriptive of a relation variously defined in the cases as “adjunct,” “branch,” “instrumentality,” “dummy,” “buffer,” and “tool,” but all in the sense of “means” through which a corporation’s own business is actively prosecuted; or of the relation created when two corporations are in substance identical though operating under’ different names. But in every case in which a corporation has been held liable for the debt of another because of dominance or control through stock ownership or otherwise and not depending on principles of agency or es-toppel, the reason was that to hold otherwise would result in a wrong for which the law must find a remedy. For the purposes of this discussion, “agency,” “adjunct,” “branch,” “instrumentality,” “dummy,” “buffer,” and “tool,” all mean very much the same thing.

“Adjunct” is defined by Webster to be: “Something added to another thing, but not essentially a part of it.” Murray’s definition is: “Joined or added (to anything); connected, a'nnexed; subordinate. Something joined to or connected with another, and subordinate to it in position, function, character or essence; either as auxiliary to it, or essentially depending upon it.” If “adjunct” is to be given its defined meaning, its use is unfortunate, for it describes a relation the opposite of that which the court using it had in mind, and all systems of control exercised by corporations over their subsidiary companies through ownership of stock or because of identity or substantial identity of stockholders or directors are illegal, and the rule of the separate entity and responsibility of corporations for their own acts and contracts is swallowed up in the exception. This cannot be.

From an examination of many decisions, we venture to say that no corporation acting within its powers has been held liable for the debts of another corporation legally organized, because it controlled such corporation by reason of ownership of its stock, or otherwise, except by reason of contract or on grounds of agency, or of estoppel, or because the controlled corporation has been used in such a way that the maintenance of its character as a separate and distinct entity would work injustice. The cases are too numerous and some of them too complicated for elaborate discussion here, but attention may be called to a few by way of illustration:

Interstate Tel. Co. v. B. & O. Tel. Co. of Baltimore County and Baltimore & Ohio R. R. Co., 51 Fed. 49 (C. C.), affirmed in 54 Fed. 50, 4 C. C. A. 184 (C. C. A. 4), headnote in the Circuit Court by the district judge:

"The Baltimore & Ohio Railroad Company, having power to transact a general telegraph business, and being the owner of an extensive telegraph system, caused the Telegraph Company of Baltimore County to be incorporated with a small capital, and in its name made a contract with the complainant. For breach of that contract.the complainant recovered judgment against the Telegraph Company of Baltimore County. The Baltimore and Ohio Railroad Company sold out its whole telegraph system to the Western Union Telegraph Company, and the Telegraph Company of Baltimore County was left without assets of any kind, and became insolvent. Held, that as the railroad company was the sole stockholder of the Telegraph Company of Baltimore County, and appointed its officers, and held it out as having authority to contract with regard to the whole system owned by the railroad company, the Telegraph Company of Baltimore County was a mere agent of the railroad company, a mere name, in fact, under which the railroad company conducted its telegraph business, and that, under the circumstances of this case, a court of equity had jurisdiction to decree that the railroad company, as principal, should pay complainant’s judgment against its agent, from which it had taken all the property which it had represented that its agent controlled.”

In the case In're Muncie Pulp Co., 139 Fed. 546, 71 C. C. A. 530 (C. C. A. 2), that company, a New York corporation, manufactured pulp at Muncie, Ind. It organized the- Great Western Natural Gas & Oil Company to furnish it with gas or oil to which it transferred its gas and oil well property. It made various expenditures for the benefit of the Great Western Company, which it treated as an agent which the law made necessary for the full development of its business. The Great Western Company kept no separate set of books. Its entire administration department was under the control of the Muncie Company, and it had no creditors. Two persons owned all of the stock in each corporation. On the bankruptcy of the Muncie Company, the petition of its receiver that the Great Western Company turn over to him the property in its name, it was held that the assets of the Great Western Company were the assets of the Muncie Company, and that the stock of the former belonged to the Muncie Company, and was held by those in whose name it was as trustee for that company. The ground of the decision was that to hold - otherwise would be a fraud on the creditors of the Muncie Company.

In Gay v. Hudson River Elec. Power Co., 187 Fed. 12, 109 C. C. A. 66 (C. C. A. 2), the Hudson River Electric Power Company had eight associated and subsidiary corporations, one of which was the Hudson River Electric Company, a distributing and not a generating company. The subsidiary company contracted with the General Electric Company to furnish it power, payment for which was to be made to the subsidiary company. It furnished power, amounting to a large sum. The General Electric Company sold merchandise to the controlling company in approximately the same amount it owed for the power to the subsidiary company. The question was whether or not the debt of the General Electric Company to the controlling company could be set off against the debt of the General Electric Company to the subsidiary company. The decision went on the ground that the set-off could be made because of an agreement to that end between the parties. The opinion was by the same judge who wrote the opinion in the case In re Watertown Paper Co., in which the doctrine of the second exception was first declared. Referring to that case and quoting the exception announced in it, the learned judge said (15):

“Titere would be much ground for holding that the Hudson River Electric Company comes within Hie second exception to the rule of distinct corporate existence. The record clearly indicates that it was organized and controlled asa subsidiary corporation, and that its affairs were so conducted as to make it, practically, an adjunct of the managing corporation — the Hudson River Electric Potter Company. It would seem that we would not he departing from established principles if we should regard this book credit of the Hudson River Electric Company as really existing in favor of the managing corporation, the Electric Power Company, against which, without special agreement, this demand against the managing corporation might properly be oifset. It would be equitable so to hold. The Hudson Electric Company did not generate the power which it sold. It obtained it only through the bookkeeping of the managing company from another subsidiary corporation. The managing corporation did not use the merchandise which it bought. It distributed it among tiie various subsidiary companies. The offset could hardly be regarded as unfair to the Hudson River Electric Company, while it would, be grossly unfair to the General Electric Company to compel it to pay its indebtedness to one of the companies and to look to an insolvent associate for the payment o£ its own account.

“But it is unnecessary to decide this case upon the ground just considered, and we distinctly refrain from so doing.”

This language is open to the inference that the court hesitated tc apply the doctrine, although seemingly applicable. If it were, there would seem to be no reason why the offset should not have been allowed, both because the relations of the company were such that one was an adjunct of the other, and because of express agreement to that end. This hesitancy makes the case the more valuable in this discussion, because it is of the court which first announced the doctrine, and the decision is more important still, because the doctrine, had it been applied, was expressly based on the unfairness to the General Electric Company of denying the offset. ,

In Stark Electric R. Co. v. McGinty Contracting Co., 238 Fed. 657, 663, 151 C. C. A. 507, McGinty Contracting Company entered into an agreement with Interurban Construction Company for work done in the construction of the Stark Electric Railroad. This court held that the Suburban Company was but a “dummy” or “buffer” organized by the Electric Company; that McGinty Company “believed in good-faith that its contract was in reality with the railroad company” and “that the construction company for the convenience of the railroad company, and with the knowledge of everybody interested in the transaction, was, with respect to the contract in question, 'masquerading, acting for and put forth substantially as’ the railroad company.” Justice required the railroad company to be held liable for its construction company’s contract, and it was so held.

Foard Co. v. State of Maryland, 219 Fed. 827, 135 C. C. A. 497 (C. C. A. 4), involved negligence in admiralty. Carelessness of a workman of the Stevedoring Company in stowing dynamite in a ship caused great damage. Foard Company ship brokers and agents, organized that company as a department of its business. The companies had the? same officers. Foard Company handled all the funds, and paid all the losses which were dealt with as if they were its own losses. It kept all the profits. It was held that the Stevedoring Company was organized and controlled and its affairs so conducted as to malee it a mere instrumentality of the Coal Company, and for that reason the two corporations must be regarded as to the outside public, identical. The cases relied on are Interstate Telegraph Co. v. Baltimore, etc., Co. (C. C.) 51 Fed. 49; same case in 54 Fed. 50, 4 C. C. A. 184; In re Watertown Paper Co., 169 Fed. 252, 94 C. C. A. 528; and Chicago, etc., Co. v. Myers, 168 Ill. 139, 48 N. E. 66 — showing that the ground of the decision was the injustice of holding only the Stevedoring Company responsible for the damage which was caused really by the Foard Company acting through its Stevedoring Company In the Illinois case, the Gas Company was held responsible for the injury, because the construction company was “its mere agent or tool.”

Whatever “adjunct” may mean in this connection, it must, to be applicable at all, be given a new definition, involving the idea of sinister purpose or «wrongful results. If it means agency or instrumentality in the sense of means to effect wrong, or through which wrong is done, we would be content with it. But it is a word too uncertain in meaning to be incorporated into an inexorable rule of law as an exception to a just rule long established unless qualifiéd in such a way as to cover the kind of cases to which it was intended to apply; cases in which adherence to the doctrine of the separate and distinct entity of a corporation would work injustice.

It will he noticed that, when the exception was first declared, no authorities were cited as a basis for its deduction. We have found none, and in all the decisions we have examined, in which corporate entity has been disregarded, the reasons were principles of agency, or estoppel, or because justice required it. The law on the subject will be found, we think, in the Second Carpenter Case, wherein it was said:

“That a court of equity will disregard corporate forms when they have been used to do injustice.” 235 Fed. 17, 28 (148 C. C. A. 511).

And we approve what was said by Judge Sater (In re Rieger [D. C.] 157 Fed. 609, 613):

“The doctrine of corporate entity is not so sacrod that a court of equity, looting through forms to the substance of things, may not in a proper case ignore it to preserve the rights of innocent parties or to circumvent fraud.”

We do not think the Circuit Court of Appeals in the Second Circuit, when announcing the exception, had in mind, by the use of the words under discussion, any meaning different from the interpretation they seem to us to bear, and we cannot accept the exception unless qualified in substance as suggested.

We are of opinion that, whatever the relation between the Wheeling and the Coal Company was, no injustice is worked to these bondholders by holding the bonds to be executed and delivered by the Coal Company in its corporate capacity separate and distinct from the Wheeling and as its own debt. For reasons we need do no more than to quote from the views of this court heretofore expressed. In the First Carpenter Case, 218 Fed. 273, 283, 284 (134 C. C. A. 69):

“ * * * This coal company existed only on paper, and was owned and controlled by the railroad company. It made no move of its own volition but was manipulated by the railroad company for its own purposes and in Its own interests. But even if this is true, the bondholders knew the relation of the railroad company to the coal company, and with that knowledge accepted the bonds. It therefore cannot be held that the prior lion obligations are the contract debt of the railroad company in the sense that it itself executed those obligations. Such a holding would necessarily involve the indebtedness of the railroad company on the bonds themselves. This the bondholders do not claim. No corporate form was used to deceive them. So far as express contract rights are concerned, the bondholders dealt with the coal company as a separate and distinct entity.”

Then the opinion dealt with the implied agreement of the Wheeling to furnish sufficient cars.

In the Second Carpenter Case, 235 Fed. 17, 28 (148 C. C. A. 511):

“ - * * Absolute good faith, so far as the use of corporate forms and the relation of the Railroad Company to the Coal Company and to the bondholders are concerned, dominated the dealings between the bondholders and the Wheeling, and their entire transactions were on the basis of the Coal Company’s separate and independent corporate existence. There is no ground upon which to base a finding that these bonds are, either at law or in equity, a debt of the railroad.”

Again (235 Fed. 27, 148 C. C. A. 511):

“The prior lien obligations and the bonds of the Wheeling’s Coal Company involved" in Carpenter’s suit wore the debt of the Coal Company, secured by mortgage on its land and property. The bondholders took the bonds on that understanding. They knew the Coal Company was but an adjunct and agency of the Wheeling, yet they did not look to the Wheeling for the payment of those obligations to the holders thereof, and for the payment of the bonds to themselves, because of that relation, but expressly contracted witli it for contributions to be paid by it to be applied, together with royalties paid by Hanna & Co/s Mining Company, to the payment, first, of the prior lien obligations, and, second, to the bonds on allotment under the plan upon which the Coal Company was reorganized. It was undoubtedly expected that, during the operation of the plan for its 10 years of life, the prior lien obligations would be paid off and something paid on the bonds, and then, by some new arrangement, the mortgage debt of the Coal Company, being by that much reduced, could be taken care of out of the mines of the Coal Company.”

Assuming that the issue was not raised in the First Carpenter Case, and conceding that the views of this court in the Second Carpenter Case were, for reasons given in the opinion on the petition for a rehearing, obiter dicta, nevertheless the status' of these bonds was a question, under the circumstances in each case, such as to naturally provoke discussion and it received the deliberate consideration of this court. After careful reconsideration, we see no reason to depart from the conclusions therein expressed.

On the contrary, we think the allowance of these bonds as a debt against the Wheeling would be clearly an injustice to it. Assuming the exception to be as stated, yet the bondholders cannot avail themselves of the assumption. They were a party to the plan of reorganization of the Coal Company which committed its ownership and control to the Wheeling. The purposes of the plan were to pay off the prior lien obligations; the interest on these bonds and as many of the bonds themselves as the plan’s operations permitted. The bonds were to be paid out of the successful operation of the plan and out of the coal lands mortgaged, for their security. This was the understanding of the bondholders and of the Wheeling.

From the day that plan was adopted, the relation of the Wheeling to its Coal Company has not changed. If these bonds are tire Wheeling’s obligations now, they were then. Yet, notwithstanding the elaborate arrangement for the protection of these bondholders, to which they were a party, they would now ingraft on the Wheeling an additional obligation to pay the bonds in any event as its own debt. The bondholders’ rights under that arrangement are based on the separate corporate 'existence of the Coal Company. The rights they now claim are based on its nonexistence. As to them, it was one or the other, and could not be both. The bondholders, with full knowledge, chose to treat it as a separate corporation distinct from the Wheeling, and on that theory they obtained a recovery in the First Carpenter Case. They cannot now, to the injury of the Wheeling, obtain a recovery on the ground that it was not 'distinct from the Wheeling but was the Wheeling itself. It was not the intention of the bondholders or the Wheeling that the. Wheeling should be liable on these bonds; and it may safely be said that if the Wheeling had known that the bondholders claimed, or evfer would claim, that, in effect, the Coal Company’s bonds were its obligations because the Coal Company had no separate corporate existence from it, it never would have devised and become a party to the plan for the payment of these bonds based on the Coal Company’s separate corporate existence.

It follows from all of these considerations that the decree of the 'District Court should, and it will, be, reversed, at appellee’s costs.