McCornack v. Salem Railway Co.

Mr. Chief Justice Wolverton,

after stating the facts, delivered the opinion.

We assume at the outset, as it seems to have been conceded by the parties to this controversy, that defendant corporation and its mortgagees holding liens upon its franchises and property, are subject to rules and regulations like those governing the management, control, and disposal of the property and assets of companies and corporations engaged in the operation of ordinary railroads, with quasi public functions to perform. It has become a settled principle under the authorities that where a mortgage is taken upon the property, and even upon the earnings, of such a corporation it is implied, from the nature of the business in which the concern is engaged, and the usual and ordinary management and conduct of such business, that the current earnings of *547 the enterprise shall be first applied to the payment of the current operating expenses, such as for labor and supplies, and for necessary equipments and improvements of the mortgaged property, and that the balance only, usually termed the “net earnings,” shall be applied in payment of the mortgage indebtedness. In the language of Chief Justice Waite, in Fosdick v. Schall, 99 U. S. 235, 252 , “every railroad mortgagee, in accepting his security, impliedly agrees that the current debts made in the ordinary course of business shall be paid from the current receipts before he has any claim upon the income.” This doctrine rests upon the ground that the maintenance of the road and the prosecution of its business are essential to the preservation of the mortgage security. The primary object is to keep the enterprise a going concern, from considerations of both public and private interest. Its application is concisely stated by Thayer, Circuit Judge, in Central Trust Co. v. Clark, 26 C. C. A. 397 ( 81 Fed. 269 ). He says: “In a suit brought to foreclose a mortgage lien upon the property of a quasi public corporation, it is competent for a court of equity to award a preference to a claim for property supplied or services rendered to such corporation, when it appears that the property so supplied or the services rendered were necessary to enable the company to discharge its public obligations and remain a going concern, and when it is evident that the property or services in question enhanced the value of the mortgaged property, and thereby inured to the benefit of the mortgagees.” The management of such a concern, whether in the hands of its promoters or in those of a receiver, is charged with the duty of so marshaling the funds arising from current earnings as to apply them in accordance with the relative equities of the preferred creditors and the mortgagee; and if, through regard for mere conven *548 ience, something is taken from the fund and paid to the mortgage creditor, when as of right it belongs to and should have been paid to the preferred creditor, it is not considered inequitable, unless the claim has become stale, to require that the preferred creditor shall be paid from the future current receipts, or from the proceeds of the sale of the mortgaged property. Simonton, Circuit Judge, in Southern Ry. Co. v. Carnegie Steel Co., 22 C. C. A. 289 ( 76 Fed. 492 ), pertinently states the rule as follows: “If, through inadvertence, or by intention, or from any other cause, any portion of the earnings has been applied to interest or dividends, or to the permanent improvement of or addition to the property, leaving unpaid debts incurred for things necessary to keep it a going concern, this is a diversion which the court, while aiding the mortgage creditor, will first correct.” *

It is from considerations of this nature that the courts are induced to require, as a condition of the appointment of a receiver, that the mortgagee shall consent to the payment of such equitable demands as are outstanding against the company, which have accrued within a reasonable space of time prior to the receivership, and, even in cases where the condition is not primarily imposed, to require that the receiver shall adjust the current receipt fund in accordance with the equities thus to be ascertained, and, under certain conditions, reimburse the preferred creditor from the corpus of the estate, and to that extent displace the mortgage. In further support of these observations, see Bound v. South Carolina Ry. Co., 7 C. C. A. 322 , 58 Fed. 473 ; National Bank of Augusta v. Carolina, K. & W. R. Co., 63 Fed. 25 ; Thomas *549 v. Peoria, etc. Ry. Co., 36 Fed. 808 ; Wood v. New York & N. E. R. R. Co., 70 Fed. 741 ; Hale v. Frost, 99 U. S. 389 ; Miltenberger v. Logansport R. R. Co., 106 U. S. 286 (1 Sup. Ct. 140); Thomas v. Western Car Co., 149 U. S. 95 (13 Sup. Ct. 824). It is often a difficult matter to determine what are preferred claims and what are not, depending to a large extent upon the particular circumstances of each case. According to Chief Justice Waite they must be such as have accrued for “necessary operating and managing expenses, proper equipment, and useful improvements Fosdick v. Schall, 99 U. S. 235 . It is clear from the authorities, however, that claims cannot be included which may arise on account of additional equipments provided, and valuable and lasting improvements made: Smith, Rec. §§ 342, 343; Williamson's Admr. v. W. C. etc. R. R. Co., 33 Gratt. 624 . As an illustration of the requisites which should attend the preferred claim, we will refer again to the case of Central Trust Co. v. Clark, 26 C. C. A. 397 , 81 Fed. 269 . It is there said : ‘ ‘The gear wheel which was supplied by the Midvale Steel Company to the mortgagor company was an important and essential part of its plant, without which the railway company could neither discharge its duties to the public nor realize an income by the use of the mortgaged property. It was necessary for the railway company to purchase a new gear wheel and pinion, in order that its cable road might be kept in operation, and that the company might preserve its franchises and remain a going concern. The machinery in question enhanced the value of the mortgaged property by as much as such machinery was fairly worth in the market.” In no sense can such claims be extended to the inclusion of those of general creditors: Kneeland v. American Loan Co., 136 U. S. 89 (10 Sup. Ct. 950); Burnham v. Bowen, 111 U. S. 776 (4 Sup. Ct. 675).

*550 Measured by the understanding thus to be gathered touching the nature of the claims or demands which are entitled to preference over the mortgage, we will consider whether the petitioners’ claim falls within the category. The apparatus and appliances furnished did not constitute an adjunct requisite or necessary to keep the enterprise a going concern. They were at first en-grafted as an experiment, but, by design of both parties to the contract, were finally constituted a new and additional improvement. This improvement, it is true, added to and enhanced the value of the mortgage security ; but, in so far as it is shown by the petition, the allegation as to its necessity, under the rule, either in the interest of the public or the 'mortgagees, is entirely wanting. The enterprise was a going concern before such improvement, and would have so continued without it. In support of their claim the petitioners allege that since the appointment of the receiver $3,000 have been expended out of the current earnings, in payment of improvements and betterments; but we find from the petition that such improvements consisted in placing new poles for electric wires, laying new ties and rails, etc., which were clearly necessary for putting the road into such condition that' it might be safely operated. The expense thus incurred was, therefore, properly paid out of such current earnings. But such outlay furnishes no criterion in dealing with the petitioners’ claim, for the reason that it was not for necessary appliances and improvements; nor does the allegation that the agreed consideration had been actually earned by the use and employment of the apparatus relieve the petitioners from showing the necessity for the expenditure, under the rule. The demurrer was properly sustained, and the decree of the court below will therefore be affirmed."

Aeelrmed.

¡Note. — This case has now been affirmed on appeal, and claim of the Steel Company given a preference: Southern Ry. Co. v. Carnegie Steel Co., 175 U. S. -(20 Sup. Ct. Rep. 347). See also, on the same point, Lackawanna Iron Co. v. Farmers’ Loan Co., 175 U. S.-(20 Sup. Ct. Rep. 363), and Maryland Steel Co. v. Gettysburg Electric Ry. Co., 99 Fed. Rep. 150. — Reporter.