Savage v. Miller

1. When a corporation becomes insolvent its directors become trustees for the creditors, over whose claims they can obtain no personal preference. 2. Where the note of a creditor has been lawfully preferred, the fact that directors are endorsers thereon does not defeat his preference; the result is to subrogate the general creditors to the rights of the preferred creditor against the endorsing directors to the extent of the preference.

On appeal from a decree advised by Vice-Chancellor Reed, who delivered the following opinion : The mortgage is attacked by the receiver, upon the ground that the directors of this insolvent company had such an interest in the payment of the debts secured by it that the preferences so created are voidable. The execution of the mortgage was directed by the votes of three directors of a board of five. The votes of all the three in favor of the mortgage were essential to a legal expression of the corporate will. If any one of these three directors was disqualified by reason of his adverse interest from joining in the action of the board, the execution of the mortgage was an unauthorized act. The question, therefore, as to what would have been the consequence if the mortgage had been supported by the votes of a majority of the board, apart from the votes of interested directors, is not presented for solution. I will take up each of the five debts in the order in which I have stated them. The company was, as I have already observed, insolvent at the moment when the mortgage was created. The debts secured were only part of the general debts then existing. The preferences, if valid, will exhaust the assets. That the directors of an insolvent company could, previous to the act of March 5th, 1895, prefer some of its creditors to the exclusion of others was decided by the court of errors in the cases of Wilkinson v. Bauerle, 14 Stew. Eq. 635, and Vail v. Jameson, 14 Stew. Eq. 648. In the subsequent case of Montgomery v. Phillips, 4 Dick. Ch. Rep. 203, decided in the same court, the court, while recognizing the general power of an insolvent corporation to prefer creditors, circumscribed the generality of the rule by holding that if the directors were themselves the creditors who were preferred, then their interest as creditors was inimical to their duties as trustees for all the creditors, and their act in making such preferences was voidable. Under the doctrine declared in the last-mentioned case the mortgage now questioned, so far as it secures the note for $2,500 given to George W. Miller, and by him passed to Georgina M. Johnson, is clearly voidable. It was made to secure an antecedent debt due to Mr. Miller, one of the directors of the company. The next one of the debts so secured was that of the Union County Bank. Upon the note which the bank held as evidence of this debt the three acting directors were endorsers. The mortgage was made to secure the bank, and not made directly to the endorsers to secure them against their liability as such. I am at a loss to perceive how this fact can create a difference in the attitude of the directors toward this debt. The principle upon which Montgomery v. Phillips was decided was that the directors were trustees for all the creditors, and that, as trustees, their conduct in the distribution of the property of the company among its creditors should not be influenced by any personal interest adverse to the interest of the general body of creditors whom they represented. It applied to the directors of an insolvent corporation, as trustees, the same restrictive doctrine that is applicable to all trustees. 1 Perry Trusts § 207. Now, it is transparent that the effect of the mortgage, so far as it subserves the interests of the endorsing directors, was exactly the same as if it had been made directly to them to secure them against their liability as endorsers. The fact of the corporation insolvency led, necessarily, to a certainty that these directors would be called upon to pay a part of the note; and whether the property of the corporation should be used to pay the entire debt due the bank, or whether it should be used to reimburse the endorsers, in case they became liable to pay the bank, did not matter. The relief which they received from the burden of their contract, as endorsers, was exactly the same whether the mortgage was made in the one or in the other form. Nor does the fact that the directors of the bank or otherwise interested in that institution, and so would not in that way profit by the payment of this debt, remove the act of the directors from the control of the rule mentioned. The bank had no right to a preference; it was only an act of grace on the part of the directors. The void-ability of the directors’ acts does not spring from the fact that the trustees had a common interest in the two corporations, but arises from the fact that they were serving their own interest in making the preference. It is the bias which destroyed that judicial discretion which should control them when dealing with the assets of the corporation, that invalidates their act. Upon principle, then, I am unable to perceive how it is possible to condemn a mortgage made to an endorser, and to approve of a mortgage so made as to benefit the endorser in exactly the same degree. In Lippincott v. Shaw Carriage Co., 25 Fed. Rep. 585, it was held that the votes of two directors who assisted in authorizing the making of a mortgage to secure a note upon which they were endorsers, were nullities. I am aware that in Montgomery v. Phillips this apparently inevitable conclusion does not seem to have been carried to a legitimate result; for in that ease the assignment to the bank of the accounts of the corporation for the purpose of paying a note discounted by the bank and endorsed by a director, would come under the ban of this rule. But the attack upon the assignment in that case was made solely upon another ground, which ground is set out in the opinion. Only the chattel mortgage in that case was attacked, upon the ground that it was made by a director to secure himself. The rule laid down by the court was, through oversight, not applied to the assignment of the bank accounts. So in Wilkinson v. Bauerle, supra, the question discussed was whether the directors of an insolvent company could secure creditors. The exception which limits this general rule was not discussed. The third debt secured is the $6,143 note held by Georgina M. Johnson as executrix of her husband, to whom the money had been due. George ~W. Miller, who prepared the mortgage and was one of the voting directors, as already remarked, was her father, and was in the transaction looking after her interests. His position, both as attorney and relative of Georgina M. Johnson, was entirely inconsistent with his position as trustee, representing the general creditors of the company. I adopt the language of the court in Adams v. Kehloy Milling Co., 25 Fed. Rep. 435, as sound and singularly pertinent: “ If the directors of an insolvent corporation in the distribution of its assets pay a certain creditor in full to the exclusion of others, the choice ought to be influenced solely by relationship existing between the directors and the creditors preferred, or by other considerations of a purely selfish nature. In the present case it is the estate of a deceased director and president of a corporation that was preferred. The majority of the board were brothers of the deceased; one of them was agent for the estate, and controlled and voted its stock in corporate meetings.” The preference was set aside. The fourth debt secured is the note given to pay the Hall Signal Company for advances previously made by the latter company to the insolvent corporation. This note was turned over to Georgina M. Johnson in part payment of the debt which the Hall Signal Company owed her husband’s estate. Mr. Hall, one of the directors, and acting vice president of the insolvent corporation, was a stockholder and director of the Hall Signal Company. This, as a matter of course, unfitted him for acting as trustee in this transaction. Besides this interest of Mr. Hall, which disqualified him from voting for the execution of the mortgage to secure this note, Mr. Miller stands, in the same posture in regard to this as he does in respect to the preceding note. The mortgage, so far as it preferred this note, is a nullity. The last of the preferred creditors is Kernochan. There is nothing in the testimony to show that any of the directors who voted for the execution of this mortgage were interested in the payment of this debt, in any way distinct from their interest in the payment of the debts of the general creditors. There is nothing, therefore, to invalidate the mortgage, so far as it secures the payment of the Kernochan debt, flowing from the relation of the directors with Kernochan. But it is insisted that the mortgage is void in toto because it was ordered by persons who were not legal directors of the corporation. It appears that the by-laws originally provided for the election of directors at the annual meeting of stockholders, and for the amendment of the by-laws at an annual or a special meeting called for that purpose. The board of directors themselves, without authority, amended the by-laws regulating the election of directors, so that the board could appoint to fill vacancies, and, in pursuance of such amended by-law, appointed two of the directors who ordered this mortgage. These appointees remained in office from 1890 till January 18th, 1895. In the meantime, stockholders’ meetings were held, the right of these appointees to hold their offices was not questioned, but, on the contrary, recognized. They were held out, by the assent of the stockholders, as the agents of the corporation. They were directors defacto. The equitable rights of the cestuis que trust under the mortgages are not affected by the irregularity in the manner of their appointment. The remaining feature of the cause which has presented itself is this, viz., is the mortgage so tainted by the general purpose oí the directors who ordered its execution as to avoid it in toto f If it had appeared in the case that the preference of the Kernochan debt was essential to a successful carrying out of the .scheme to prefer the other creditors, there would have been force in the notion that the same condition of mental bias which induced the preference of the directors, induced the preference of Kernochan. But nothing whatever appears in the case to show that the Kernochan debt was in any way related to the other debts, or why Kernochan was included in the list of preferred creditors. The mortgage should be decreed void, so far as it secures the debts other than that of Kernochan.