St. John v. Erie Railway Company
APPEAL from the Circuit Court for the Southern District of New York; the case was thus:
By an act of the legislature of New York of the 24th of April, 1832, a corporation known as the New York and Erie Railroad Company was created. The road which the company built extended from Piermont, a town on the west side of the Hudson, some sixty miles north of New York, and just above the line which divides the State there from New Jersey, to Dunkirk on Lake Erie. To reach Piermont from the city of New York by rail, the company ferried its passengers and freight across the Hudson to Jersey City, opposite to New York, and carried them from its depot there northward alongside of the Hudson, upon roads in New Jersey which it rented.
The company had also other rented roads.
The money put into the road as capital stock being insufficient to complete it and carry it on, it issued five successive sets of bonds, amounting in the aggregate to $20,000,000. The first set was secured by a lien upon the road given by statute. The other sets were secured by mortgages, according to the order of their issue. It also issued bonds, not thus secured, to the amount of $7,000,000. In 1859 the company became bankrupt. Proceedings in foreclosure were instituted to enforce the last two mortgages, and a receiver was appointed.
In this state of thigs, on the 22d of October, 1859, the shareholders and creditors of the company entered into an amicable agreement providing for the adjustment of its liabilities. In pursuance of this agreement all the property and effects of the company, including the then existing leases of the roads rented, were sold under a decree in the foreclosure suits, and bought in by trustees for the benefit of the parties in interest, pursuant to a clause in the agreement. A new corporation, under the name of the Erie Railway Company, was organized, pursuant to acts of the legislature of New York of the 4th of April, 1860, April 2d, 1861, and March 28th, 1862, and all the property of the old company bought by the trustees was transferred to it, subject however to all the liens and incumbrances upon it which subsisted before the foreclosure and sale. The agreement above mentioned of the 22d of October, 1859, was incorporated into the decree of sale, and was recognized and sanctioned by the several acts of the legislature under which the new corporation was organized. It was also made a part of the articles of association or charter of that company. Its obligatory effect in this case was not questioned. The third article declared:
'The capital stock of said company is divided into common capital stock and preferred capital stock. The whole amount of said common stock of said company is 115,500 shares, each of the par value of $100, being in amount equal to the outstanding capital stock of the New York and Erie Railroad Company. The whole amount of the preferred capital stock of said company is to be equal to the amount of the total unsecured and judgment debt of the New York and Erie Railroad Company, with interest thereon as provided by the contract referred to in said acts, and by the provision of the said act, passed April 2d, 1861, when ascertained pursuant to the provisions of said act.'
The fifth article of the agreement was as follows:
'Such of us as are holders of the convertible sinking fund and other unsecured bonds of said company hereby agree to exchange our respective bonds for preferred stock of like amount with the principal of our bonds, with coupons now overdue, and for two years in advance added, and to deposit our bonds with said trustees to be so exchanged, receiving therefor receipts. Such preferred stock is to be entitled to preferred dividends out of the net earnings (if earned in the current year, but not otherwise), not to exceed 7 per cent. in any one year, payable semi-annually, after payment of mortgage interest and delayed coupons in full.'
The act of April 2d, 1861, in its fourth section, thus enacted:
'SECTION 4. Said preferred stock shall be entitled to preferred dividends out of the net earnings of said road if earned in the current year, but not otherwise, not to exceed seven per cent. in any one year, payable semi-annually, after payment of mortgage interest and delayed coupons in full. And the holders thereof may vote personally or by proxy at all meetings of the corporation, in the same manner as the holders of common stock, but not otherwise.'
In virtue of these arrangements, one St. John became the holder of three hundred shares of the preferred stock.
After the issuing of the preferred stock the new company took leases of several additional roads, some of which proved profitable and others not so; and borrowed 1,000,000, for which it gave sterling bonds bearing interest at the rate of six per cent. per annum, payable in gold. The money was borrowed for the repair and equipment of the roads of the company, and was expended accordingly.
The company paid the 'delayed coupons,' and a dividend of five per cent. on all the preferred stock for the year 1863, and seven per cent. annually thereafter until the year 1868; but after that time paid nothing upon that stock. On the contrary, it paid, in preference, the rents on the leases, the new as well as the old, and the interest on 1,000,000 sterling loan, as well as on the old secured $20,000,000.
The net earnings of the company during the year 1868, after deducting the interest paid on the mortgage debts existing when the preferred stock was issued, were so inconsiderable that payment of all the rents and of interest on the sterling bonds absorbed more than all of them. If no rents and no interest upon the sterling bonds had been paid during that year, there would have been more than enough of the net earnings left to pay the dividends claimed by the complainant. If no interest had been paid on the sterling bonds, and no rents under the leases made since the preferred stock was issued, there would have been enough remaining to have paid a small part of the dividends; but no part of such dividends could have been paid without leaving unpaid some part of the interest upon the sterling bonds, and of the rents under the leases made since the preferred stock was issued.
To explain the matter by figures—
The rents payable for the old leases, assumed in 1862,$372,000
"" " new leases made after 1862, 376,000
Interest, &c., payable on the £1,000,000 sterling
gold bonds, 388,500
The net earnings for 1868, of the main road and of all
the rented roads, after deducting interest
($1,286,000) on the old, that is to say the
secured bonds, was $680,000
The preferred stock, both in 1862 and 1869, was about $8,536,000.
In the keeping of the accounts of the company, the leased roads were treated as part of the whole road. No separate accounts of each were kept. Coal traffic, however, passing over one of them, taken after 1862, was stated to be very profitable.
In this state of things St. John filed in 1869 a bill in the court below against the company, asserting that he was entitled to have full dividends paid to him before any part of the net earnings were applied in payment of the interest on the sterling bonds and the rents under the leases of roads after 1862 to the new corporation. His position was that his rights were to be determined by the state of things which existed when his stock was issued, and that they were not affected by the leases taken and the bonds issued by the company afterwards.
The company on the other hand insisted that this interest and the rents of all the leases were necessarily to be first fully paid.
The court below was of the company's view, and dismissed the bill. St. John took this appeal.
Mr. D. B. Eaton, for the appellant:
I. Both the circumstances surrounding the parties when the contract was made and the language of the contract itself support the view which we take.
1. As to surrounding circumstances. The now preferred stockholders were, prior to the contract, creditors; and, to say nothing of their right to attack mortgagees, they could get judgments on their bonds, which would secure to them payment immediately after payment of what was due on the mortgages, and take precedence of all future obligations to pay rent on new roads or interest on new loans. With the right to get judgments on their bonds, and so to come in immediately after the mortgagees, it is unreasonable to suppose that they meant to open a measureless space between themselves and the mortgagees by giving the company power not only to create an unlimited number of leases, but power also to create enormous amounts of debt; to let in, prior to themselves, other unsecured bond creditors and the lessors of new roads leased-both to an indefinite amount-and to put in those persons-strangers-instead of themselves, next to the mortgagees; to expose themselves, in short, not only to enterprises untried, but to obligations unlimited. It is to suppose more according to what these bond creditors would have naturally done, if we suppose that in giving up the valuable right which they did give up, they meant to secure for themselves a certain and abiding position next to the then existing mortgagees upon the net earnings of the company well defined; to get a right to a dividend from specific net earnings from specific property next after the payment of specific mortgage interests, and that while they deprived themselves of the power of seizing the road and everything belonging to it on execution, and gave up the chance of getting the principal of their debt, they did not, as creditors, waive their then existing right of priority to interest. The state of the road, its income and outgoes, were before them; and on the prospects thus presented they could act intelligently. But on the view taken by the opposite side, they were out at sea, and dashing ahead without chart or compass, in waters where there were no soundings, and in a fog where they could discern nothing before them.
2. The language of the contract conforms with the probabilities indicated by surrounding circumstances. Had the company's now views been those of the parties to the contract, it would have been sufficient to have said that the holders of the unsecured bonds should have a preferred stock. That, of itself, would, in law and common understanding, mean a stock entitled to a preferred dividend. Or if the parties desired to be pleonastically certain, they might have added that the holders of 'such preferred stock should be entitled to preferred dividends, each year, if earned.' But the language is very different. 'Preferred stockholders' are to have 'preferred dividends' out of 'net earnings,' after payment of 'mortgage-interest,' not 'before dividends on common stock.'
The reading of the other side assumes that the makers of the agreement thought that, except for language to the contrary, a preferred dividend would be payable before mortgage-interest; an assumption impossible to make, conceding to the persons who drew the contract any knowledge of the law at all.
The fact that the existing security may be called 'stock,' and that its holders may vote with the common stockholders is unimportant. The security, however, is not called stock, but is called preferred stock, and its holders are preferred stockholders. The only question is, to whom and to what are they preferred? Suppose that the contract declared in terms that what the preferred stockholders were to receive should be paid in preference to rent on new leases, or interest on new debts? How then? Would the calling that on which they are to receive a payment preferred stock impair their rights? Plainly not. Indeed, are not debt and stock often used as convertible terms? Do we not speak continually of stocks of the States, and of the United States, meaning debts due by them respectively? Certainly we do. Indeed this very court does so. In the Bank Tax Case,  Nelson, J., delivering its unanimous opinion, speaking of the New York Banking laws says:
^1 2 Wallace, 207.