Montgomery v. Phillips

1. A board of directors of an insolvent corporation cannot, by mortgage upon the corporate property, secure one of the directors the payment of an antecedent debt due by the company to such director, or a previous liability incurred by such director for the corporation. 2. A mortgage.was made by a solvent company to one of its directors, under an arrangement that such mortgage should be kept from record for the purpose of strengthening the credit of the company, while the directors should test the success of the corporate business at the risk of future creditors, and' the mortgage was not recorded until the corporation became insolvent. — Held, that such mortgage was fraudulent.

On appeal from a decree advised by Vice-Chancellor Bird, whose opinion is as follows: I will first consider whether Thomas B. Sewell became a stockholder and thereby eligible to be elected a director, and so-clothed with authority to participate in the management of the affairs of the corporation. The utmost that can be made of Phillips’ testimony is that lie advanced the money ($700) for the purchase of twenty-three shares owned by Martinette, and that he advanced this money to Sewell; that Sewell immediately bought the stock in his own name and thereby became a director. Giving this the utmost force from Phillips’ standpoint, it was not so understood by Thomas B. Sewell — that is, that the mere act of purchasing made the stock his. Certain it is that Sewell’s testimony is in very strong contradiction of Phillips’ understanding of the case. He says he acted as a director of the company from January, 1892, until in May, when it failed. It is alleged that, on the 15th of January, 1892, the company was reorganized, and Sewell says that he did not look into the affairs of the company. He neither knew anything about its assets or its liabilities, nor had he any idea of the value of its stock. I think it is clear from the testimony that Sewell did ’nothing in the interest of this company, except to attend a few meetings cf the directors which were held between the 15th of January and the 10th of May. On the 15th of January he says he did not hold any position in the company except that of stockholder. He afterwards says that he owned twenty-three shares of stock. Mr. Martinette was the prior owner of this stock. If Sewell became the owner of any stock, it was this stock so owned by Martinette. Upon being asked whence he got the money with which to purchase the stock, he said: “A. Mr. Phillips lent it to me. “Q. When you went to Mr. Martinette, for whom were you purchasing the «took ? “A. For my brother, Michael Sewell. “Q. Did you tell Mr. Martinette for whom you wanted the stock? “A. Yes, sir. “Q. Had you had a prior conversation with your brother about it? “A. Yes, sir; he says I did not own any property; he has nothing outside of his earnings. UQ. After you left my office, on the 12th of January, with the twenty-three •shares of stock issued to Mr. Martinette, and had delivered this paper, the ■receipt, to me, who was the owner of the twenty-three shares of stock ? “A. I was. “Q. You went there to buy it for your brother, did not you? “A. I had possession of it. “Q. Mr. Phillips sent you to huy it for your brother, didn’t he? “A. Yes, sir. “Q. Were you the owner simply because you had possession of it? “A. My brother refused to take it. “Q. Why did you sign the name of ‘Henry D. Phillips, per yourself?’ “A. That is a common way of my signing papers. “Q. Did you receive that from me for Henry D. Phillips ? “A. Ho, sir. “<2. Did you sign it ‘Henry D. Phillips, per you?’ “A. I was the owner of it, because my brother refused to take it, and I was the owner of it from that time. “Q. You did not know till the next day that your brother refused to take the stock, did you ? “A. Ho, sir. “Q. In the meantime he was the oiyner of the stock? “A. My brother was. “Q. You said a moment ago you were the owner ? “A. My brother was the owner, but I had the possession. “Q. Whose money was it, as you understood it, the $700; was this your money or Mr. Phillips’ at that time ? “A. It was Mr. Phillips’ money. “Q. And you understood the stock was your brother’s, and you simply had possession of it ? “A. Yes, sir. “Q. Why did you state that Mr. Phillips loaned you the $700? ** “A. He loaned it to me as agent for my brother. “Q. Did you expect to pay it back to him ? “A. Certainly I did. “Q. On the 11th of January, when you received that money from Mr. Phillips, did you expect to pay it back ? “A. Yes, sir, I did. “Q. And Mr. Phillips was buying the stock for your brother? “A. Yes, sir; I bought the stock for my brother; my brother said that he would not take the stock and I took the stock, and after that considered1 myself indebted to Mr. Phillips, and do now. “Q. On the 11th of January did you understand this stock to be your brother’s or Mr. Phillips’ ? “A. My brother’s.” Thomas B. Sewell himself said that he had no property. He depended entirely upon his weekly wages. Phillips says that he earned $9 per week, and at one time for a short period only $7. “Q. What arrangement was made to pay you; you stated on your direct examination that Thomas was to take the stock and act as a director until he could sell; was that the understanding between you ? “A. The arrangement was he was to take that stock just as his brother did, and he was to pay me back after he sold it; I do not think he was to pay me back until he sold it, but I expected him to sell it. “ By the Court — What if he did not sell it ? “A. We did not go into that; if he did not sell the stock, I was to be the loser if I could not get the money.” Thomas Sewell says that, at and before the time of this-transaction, he knew nothing about the condition of the affairs of the company. He had no knowledge of its assets. He had not, nor did he at the time make any examination of the affairs of the company, or of its assets, or of the value of said assets. On the 5th day of March, 1892, a' resolution was passed authorizing the execution of a chattel mortgage by the company to Phillips, to secure the payment of a promissory note upon which was then due $650. This mortgage was never recorded and of no value as a security against creditors. After-wards, on the 17th day of March, 1892, a resolution was passed authorizing the company to execute a mortgage upon its real estate to Henry D. Phillips, to secure him against his endorsement upon a note for $4,300 given to the First National Bank, and also authorizing the execution of a mortgage upon all its chattels, “ to secure the payment of a loan of $650 made March 5th, 1892, and c any liability on above note.’ ” This refers to the $4,300 note. This resolution as is stated was passed on the 17th of March, with the exception of the last five words. Thosé words were added on the 9th day of May following. And it is agreed on all hands that those words were added after-wards, and there is nothing whatever in any of the minutes to show any authorization for such addition. It is claimed, however, that at an informal meeting of Shellenberger, Phillips and Sewell, it was agreed amongst them that these words should be added, and it is claimed that this is sufficient authority for their addition, and that being added in this informal way they became part of the resolution and as binding as though the words had been regularly incorporated therein. Mr. Phillips himself says that there were no other meetings after March 17th, except those which were recorded in the book of minutes. “Q. There is a meeting of April 23d, May 10th and May 18th — are you to :be understood that they were the only three meetings of thé board of directors held subsequent to the 17th of March; I mean as a board of directors ? “A. Yes, sir; there was only one other meeting; that was just prior to the •execution of the second chattel mortgage. “Q. Where was that meeting held ? “A. At my office; Mr. Sewell, Shellenberger and myself were present; it was an informal meeting, and the result was the addition of these five words; ‘there was no record kept of that meeting. “Q. Was there anything else done at that meeting ? “A. No, sir; not that I remember; probably the business of the company was gone over; I don’t remember anything else. “Q. How did Mr. Shellenberger come to your office that morning; was it for this purpose ? “A. The day he came there he came for the purpose of executing that mortgage and doing what was necessary in connection with it — the chattel mortgage of the 9th of May; he signed it that afternoon,.at the time the informal meeting was held.” Thus it appears that, on the 9th day of May, when they came to execute a chattel mortgage which had been previously authorized for the purpose of securing the $650 note, they added to the resolution the said five words, and “ any liability on above note,” referring to the $4,300 note, which had been secured by the real estate mortgage, by a resolution passed March 17th, ■ almost two months previously. They made this resolution by • an interchange of words between themselves. At best it was nothing more than this. There was not only no formal resolution passed and written upon the minutes, but there was not ■even the form of a resolution in writing. However informally it was done, the mortgage was executed. Phillips, to whom it was delivered and who was the creditor,, was the treasurer of the concern. Shellenberger, who executed it as president, was such officer. Sewell, who witnessed it, was one of the directors. There were no other directors than these three. There may be some uncertainty as to whether they were •all three together when an agreement was had that such mortgage should be executed, but as intimated, whether that be so or not, they all at one time or another joined in its execution— Shellenberger, by executing it as president; Sewell, by witnessing it and making the proof thereof, and Phillips, the creditor,, by accepting it as security. In the presence of the others, Phillips says, “ I explained the defect of the former mortgage.” “Q. What do you mean by that? “A. It was explained to Mr.- Sewell and Mr. Shellenberger that this chattel-mortgage I held, in case the first mortgage was put in execution and there-was a surplus, and there was a deficiency in the real estate mortgage, I would be a loser to a considerable amount; and that it was the understanding and the desire of the Capital Cracker Company to protect me as fully as possible; and that there was no provision in that mortgage as to the surplus, because there was a mistake in it at the time it was drawn, and this mortgage was-drawn for the purpose of curing that defect. “Q. Did you tell them it was the purpose of the Capital Cracker Company to secure you at that time ? “A. Ho, sir; not in these exact words, but in that sense. “Q. Did you mean that you, as the Capital Cracker Company, intended to-secure yourself? “A. I did not; I am not the Capital Cracker Company, nor never was. “Q. The original chattel mortgage was given to secure $650 ? “A. Yes, sir; that is true. “Q. And that did not secure you from any loss on the $4,300 ? “A. Ho, sir. “Q. And the object of that chattel mortgage was to extend the security to the $4,300? “A. It was the object to carry that surplus to the $4,300 note; that is the- . only answer I can give, sir. “Q. Was anything said by you as to including these five words, ‘and any liability on above note,’ to the March 17th meeting and resolution? “A. Ho, sir; I think not. “Q. You took that upon yourself, after the mortgage was executed, to add-the words, ‘any liability on above note?’ “A. Yes, sir; as secretary of the Capital Cracker Company, I did. “ By the Court — Is there anything on the books of the company with reference to any liability on above note, except the words there appended to that-resolution ? “ Witness — Ho, sir; there is nothing.” The foregoing statement of facts presents a very singular con- ■ dition of affairs. It is not surprising that when such a situation was made known to creditors, or to the receiver of the defendant corporation, the conviction should arise that all was conceivedi in fraud. There was an old corporation reorganized on the 15th of January, and as so reorganized was turned over to a receiver on the 20th of the May following. Yet certain facts are interspersed which lead the mind to the conviction that they could scarcely exist if the purpose of those who were engaged in the management of the defendant company was a concoction and perpetration of a scheme to injure honest creditors. The facts to which I refer are the complete prostration of the company before its reorganization, the purchase of a large number of shares of stock by Phillips, the advancement of $700 for the purchase of twenty-three shares, which he says he gave to Sewell in order that Sewell might become a director, the reorganization of the company, the loaning of $750 to the company for its own benefit, and afterwards endorsing the note of the company for $4,300 which was reduced to $4,000, and trusting the company for the payment of these sums for some time before the execution of either the real estate or the chattel mortgage. It does not seem reasonable to suppose that a business man would attempt the resuscitation of a defunct company, and would also invest several thousand dollars in its business for the mere purpose of experimenting with creditors, when, according to all experience, the probabilities were against his making it a financial success, on the belief that he could cover up the fraud by means of which he might expect to carry the work through. The observations just made should be kept in mind in considering the other facts developed, and which were relied upon by the complainant. In the first place, it is insisted that there really was no reorganization of the company. This is based upon the allegation that Thomas B. Sewell never became a stockholder, and consequently never could be a director. Taking the testimony of Sewell alone, it would be extremely difficult to get to the conclusion that he regarded himself as at all interested. It is true, he says now he had possession of the stock, and now he says he bought it for his brother. But however variable may have been the condition of his mind in relation to the facts of the case, the evidence is that he acted as a director. Phillips himself swears that, when Michael Sewell refused to take the stock, lie told Thomas B. Sewell that he should take it. The result of his testimony is that he advanced the $700, which was paid to Martinette for this stock, for the purpose of having some one become the owner of the stock, in order to comply with the law in reorganizing the company, to do which there must be three stockholders and three directors. When he learned that Michael would not take the stock, he then said to Thomas that his $700 was invested anyhow, and that he (Thomas) must take the stock and act as director. It is true that the statement of Phillips with a party with whom he was negotiating for a sale ■of some shares of stock, was the owner of forty-one shares, was inconsistent with Sewell’s being the owner of any, for without these twenty-three shares Phillips could not have been the owner of forty-one. There is nothing, however, to show that Sewell was present at this interview, or that he ever assented to any declaration of Phillips of the ownership of these twenty-three shares. But whatever was in the mind of these parties subsequent to the reorganization, there is no room for doubt but that at that time Phillips had put himself in a position towards Sewell by which Sewell could have enforced the claim to the ownership of these shares. It was upon this foundation that Sewell was made a director and participated in the reorganization and in the future managing of the affairs of the company. Without reaching this conclusion there was, indeed, no reorganization and no company, and consequently nobody with whom dealers could act except as individuals. If the facts in the case should lead us to decide that there was no reorganization and consequently no company, then it is clear that creditors would be no better off and the receiver would show himself out of court. The receiver has no standing unless it be shown that there is a corporation, such as is contemplated by the statute, whose assets are committed to him for distribution. It may be that Thomas B. Sewell was, as it is styled in the bill, “ a mere figure-head,” acting solely upon the suggestions of Mr. Phillips, echoing his sentiments or obeying his commands. There is not a little testimony in the case to justify .this insistment. It is true that the statute declares that every •director shall be a bona fide stockholder, and it is equally true that it would be far better for the business community were this ■direction enforced iu the highest and best sense, yet enough is known of the management of corporations in this state to justify the observation that a very large number of corporations organized under our statute are controlled and really owned by one or two individuals only, notwithstanding there may be a third or fourth director, but only so in name. Therefore, I come to the conclusion that there was a lawful ■organization, and that the same stockholders who were made •directors and reorganized the company continued its management ■until the filing of the bill asking that the company be declared insolvent and that a receiver should be appointed. The receiver in this case owes his appointment to the proceedings under that bill. Every step which has been taken has been upon the premise that there was a corporate existence. Had creditors come into court and set up all these facts, and declared that the scheme was adopted for the sole purpose of deception and of defrauding creditors, praying for the aid of the court in the premises, the ■argument of counsel against the allegation that there is a corporation would have had some force. But I am unable to comprehend how the complainant can come into court as the receiver •of a corporation and attempt to establish the fact that no corporation in reality existed. In the next place, it is urged that the two mortgages — one upon the real estate to secure the loan of $4,000, and one upon the personal estate to secure the sanie loan and also the loan of $650 — are fraudulent. The view taken by counsel is that they are fraudulent as to creditors for the reason ■ above given, with respect to the reorganization of the company, and that the chattel mortgage is void if not fraudulent, because there was no proper incorporated authority for its execution. With respect to the allegation of fraud, I find no proof in support. As intimated, the $650 was advanced for the benefit of the company, aud the $4,000 note was endorsed and the money used for a like purpose. There is not a shadow of testimony to the effect that either the one or the other was made •with the view of wronging anyone. The result shows that it was done with as fair a chance of misfortune to the lender and' endorser as the contrary. If the loan and the endorsement were honest transactions, then Phillips had a right to demand protection against loss, and the company had a right to pledge all its assets, not otherwise under pledge, to him as security. The company undertook to do this. The attack upon the real estate mortgage I regard as having been abandoned. The mortgage upon the chattels has the advantage of being properly executed. To this extent the defence of Phillips to the assault is complete. However, the presumption arising from this situation has been assailed. It is urged that this mortgage was executed without any authority. There is no doubt but that the president executed it, the secretary witnessed it and made the proper proof of its execution, and Phillips, the mortgagee, accepted it for the purposes therein expressed, but it is insisted that these were individual acts and not the acts of the corporation. This fact is not enough for the objectors to show to overcome the efficacy of an-instrument under the seal of the corporation. It must be clearly established that there was no act of the body corporate authorizing it. There can be no doubt but that there must be the corporate act, which is presumed from the appearance of the seal of the corporation. The weight of the testimony in this case, notwithstanding the vagaries above referred to, instead of disproving such corporate act, establishes the contrary. There was-no written resolution, but that is not essential to a corporate act. So far as the testimony was presented for the purpose of discrediting the seal proves anything, it proves that there was a-meeting of the directors at which they determined that Phillips should have the benefit of this mortgage. I do not say that the meeting was called for that purpose, or that it was called for any purpose. I only say that there was a meeting at which all three were present, during which it was agreed that Phillips should not only have the benefit of the chattel mortgage to-secure the $650, but also as further security for his endorsement upon the $4,000 note. Very much was said upon the argument concerning the addition to the resolution, above quoted, of the five words, and “ any1 liability on above note.” This resolution was adopted and entered upon the minutes upon the 17th day of March, except said five words. The words so added were not added until about the date of the execution of the chattel mortgage, which was May 9th following. The testimony of Phillips makes it clear that he had no authority to add those words to the resolution dated March 17th. It is clear, therefore, that these words have no force whatever as they are there written. It is equally clear that this fact does not impair the presumption which arises from the presence of the seal upon the mortgage which is assailed. It is equally clear that the absence of any resolution to execute such mortgage, upon the minutes of the corporation, does not overcome the presumption. But as intimated in the effort upon the part of the complainant to overcome this presumption, the weight of the testimony is rather in support of the presumption than against it. Therefore, the effort to make it appear that this mortgage, as security for the $4,000 note, is void, has likewise failed. There is nothing in the case which leads me to question the propriety of the assignment of the book accounts to the First National Bank. The company was debtor to the bank, and the company had the same right to secure the bank that it had to •secure any other creditor. Nor do I find any testimony to satisfy me that the sale of the goods and chattels of the company, under the chattel mortgage, should be declared illegal. The complainant asks for an accounting. As I understand the testimony, the sale of the goods and chattels covered by the mortgage did not produce enough to satisfy the amount due thereon, but whether the real estate has been sold or not under the mortgage referred to, I believe does not appear. If both the real and personal estate have brought •more than enough to satisfy the claim of Phillips, the receiver will be entitled to an accounting, and he will be entitled to an ■accounting in any event if he deems it to the interest of creditors to demand it, taking upon himself, of course, the risk of the costs attending such accounting.