U.S. Supreme Court St. John v. Erie Railway Company, 89 U.S. 22 Wall. 136 136 (1874)
St. John v. Erie Railway Company
89 U.S. (22 Wall.) 136
APPEAL FROM THE CIRCUIT COURT FOR
THE SOUTHERN DISTRICT OF NEW YORK
A railroad company, built originally with money contributed as stock, subsequently borrowed money, issuing its bonds at five several dates and giving five several mortgages to secure them. It also borrowed money, issuing bonds for which it gave no mortgage -- unsecured bonds. It finally proved insolvent, and proceedings to foreclose the last two mortgages were had. The stockholders and creditors now entered into an agreement for the adjustment of its liabilities, and pursuant to the agreement the road was sold under the proceedings of foreclosure to trustees, who transferred all its property subject to all the existing mortgage liens to a new corporation authorized by the legislature, with the agreement confirmed by legislative act, by which it was agreed that the stockholders of the old company should be stockholders -- common stockholders -- in the new, and the unsecured creditors of the old one be stockholders preferred. This agreement was carried out, and the
parties further agreed:
"Such preferred stock shall he 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 percent in any one year, payable semiannually, after payment of mortgage interest and delayed coupons in full. "
The new company now worked the road, and for a considerable time paid to the preferred stockholders seven percent out of its net earnings, and of course after payment of mortgage interest and delayed coupons.
However, in the course of managing its affairs it afterwards -- that is to say after the making of the above-mentioned agreements -- leased new roads, some of which were not profitable, and borrowed large amounts of money which it spent in the repair and equipment of the road, all in a mode quite regular. And paying its interest on the old debts, rent for the new roads, and interest on the additionally borrowed money, it could not pay anything more.
A "preferred stockholder" now filed a bill to have full payment of his dividends from the net earnings prior to any payment on account of the new leases or additionally borrowed money, his view being that his rights were to be determined by the state of things which existed when his stock was issued, and were not affected by the leases taken and the money burrowed afterwards.
Held that this was not a true view of the case, and that the last and italicized clause above, "after payment of mortgage interest and delayed coupons in full," was controlled by the previous word "net," which meant "that which remained as net profit after the deduction of all charges or outlay." The bill was accordingly dismissed.
By an Act of the Legislature of New York of the 24th of April, 1832, a corporation known as the New York & 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 things, 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 2, 1861, and March 28, 1862, and all the property of the old company bought by the trustees was transferred to it, subject however to all the liens and encumbrances 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 & 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 & 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 2, 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 percent in any one year, payable semiannually, after payment of mortgage interest and delayed coupons in full. "
The Act of April 2, 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 percent in anyone year, payable semiannually, 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 Ĺ 1,000,000, for which it gave sterling bonds bearing interest at the rate of six percent 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 percent on all the preferred stock for the year 1863, and seven percent 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 Ĺ 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 Ĺ 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. 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 percent, 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's 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 were 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 disintegrated 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 coal fields
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 is in hostility to the conclusions at which we have arrived.