Adams v. Eastern Massachusetts Street Railway Co.

Carroll, J. This is a suit in equity to compel the trustees of the Eastern Massachusetts Street Railway Company (hereinafter called the Company), to declare and pay dividends on the common and adjustment shares. The Company was organized under Spec. St. 1918, c. 188. This statute authorized the Company’s acquisition of the property of the Bay State Street Railway Company. Under § 2 of the statute the Governor was directed, with the advice of the Council, to appoint five trustees, who took over the property June 1, 1919, and since then have been in control; § 4 authorized the Company to issue stock, bonds and other evidence of indebtedness; § 8 provided for the payment of $1,000,000 to be used for1 the rehabilitation of the property and other corporate purposes, and by this section provision was also made for the sale of bonds, directing the purpose to which the proceeds were to be applied; § 11 gave authority to the trustees to manage and operate the Company and “exercise all the rights and powers of the new company and its directors,” “except as . . . otherwise provided herein.” By this section the trustees were given the right to fix fares, to determine the character and extent of the service and the facilities to be furnished, “and in these respects their authority shall be exclusive”; § 14 provided that the trustees were to fix such rates and fares as would meet the cost of service, which cost of service was to include, in addition to proper maintenance, operating expenses, taxes, rentals and interest on bonds, “stated dividends on the preferred stock and six per cent on the common capital stock,” as well as “such allowances for depreciation of property and for obsolescence and rehabilitation” and for such losses in respect to property sold, abandoned or destroyed as the trustees might deem adequate. — 128 — Certain dividends have been paid on the adjustment shares but no dividends have been paid on the common shares. On the back of all certificates is printed a vote of the directors, passed May 29, 1919, in part as follows: “Whenever all prior dividends accrued on the First preferred stock, the Sinking Fund stock, the Preferred B stock, and the Adjustment stock have been paid or set apart, and all prior payments to the Sinldng Fund for the redemption of the Sinking Fund stock have been made, the Public Trustees at any time during the period of public control, or the Board of Directors at any other time, may, in their discretion, declare and pay dividends on the common stock.” Each stock certificate on its face purports to give the holder the “rights . . . fixed and determined by the vote of the Board of Directors of the said company passed on May 29, 1919, a copy of which vote is printed on the back of this certificate and by reference incorporated herein.” On May 31, 1919, the stockholders of the Company voted as follows: “That the president or any vice-president and the treasurer or any assistant treasurer be and they hereby are authorized and directed to execute and issue . . . pending the preparation of permanent stock certificates, temporary stock certificates in substantially the same form authorized at the special meeting of the board of directors held Thursday, May 29, 1919.” As bearing on the effect of this action, see Boston & Albany Railroad v. New York Central Railroad, 256 Mass. 600, 609, 610, 614. The case was referred to a master to hear the parties and their evidence and find the facts. He found that the property was in poor condition when the new company came into possession of it in 1919; that some equipment was then obsolete, and from time to time the trustees abandoned a part of the property; that under § 15 of the statute the trustees divided the lines into fare districts; that new rolling stock had been purchased, rails renewed and cars repaired; that they had erected buildings and adopted many new and economical types of equipment; that including the year 1922 they had applied for the work of rehabilitation the sum of $539,044.41 of the fund provided for in § 8 of the statute, and — 129 — during this time there had been charged to operating expenses the sum of $1,920,835.03, which sum was expended for rehabilitation of the road; that under the former management the property was allowed to deteriorate and no reserve was accumulated for depreciation, and a larger part of the expense for rehabilitation was incurred because of this; that the fair investment value of the property on June 1, 1919, was the sum in respect to which it was capitalized, namely, $41,401,825.72; that the rehabilitation work which exceeds in amount the fair rate of depreciation upon that valuation is in the nature of a betterment and an increase in capital value to that extent; that the trustees did not consider that the amount fixed by the act was controlling, and that they decided that dividends could not be paid until the depreciation charges, for which no provision was made by the Bay State company, had been taken care of. The master also found, “Since the Public Trustees took control they have expended large sums for the rehabilitation of the road and equipment. Much of this work was done to restore the impaired condition in which they found the system. Under former management the old company had permitted its property to deteriorate and had accumulated no reserve for depreciation. By what they have done in this respect the Trustees have raised the road to a proper standard of efficiency. In consequence the value of the property as a whole for operating purposes is greater today than it was in 1919.” “If the balance between assets and liabilities is to be considered as having been fixed by the statute, thereafter to remain as it stood at the time of incorporation, the question would seem to be simply whether or not the revenue of the road has been sufficient to cover the cost of operation, maintain the property in the same condition as it then was, and yield the return upon invested capital specified in the Act. If the statute is so construed, it means that the trustees are to operate the property, maintain it at the condition it was in when received, and are not to improve or increase its capital value out of income until they have paid all the cost — 130 — of service, including dividends. If this view prevails, then I find that dividends have been earned.” “It is true that the road was in poor condition when the new company took it over in 1919. Since then the trustees have improved the property in every operating respect and have brought the part of it which is now in use to a high state of repair and efficiency. From June 1, 1919, to December 31, 1922, the increase of asset value of the property rehabilitated resulting from turning earnings back into property, and charging expenditures for rehabilitation to operating expense, in addition to all increases of assets shown on the books, was at least $1,920,835.03. “If the question of investment value is open after the Legislature has fixed the amount at which the property might be capitalized, I find as a fact that the fair investment value of the property on June 1, 1919, was the sum with respect to which it was capitalized, namely, $41,401,825.72, and that rehabilitation work which exceeds in amount the fair rate of depreciation upon that valuation, is in the nature of a betterment and is an increase in capital value to that extent.” The statute did not provide that dividends were to be paid on the value of the property as fixed by the commission. The cost of service included such allowances for depreciation and rehabilitation as the trustees deemed adequate, and in this respect their judgment was not limited. The trustees admit that dividends are included in the cost of service, but contend they have been unable to obtain sufficient revenue from fares to pay dividends on the common stock; that rates are sufficiently high; that passengers in one district would object to an .attempt to make them pay a part of the cost of service in another district; that such a course might bring about increased automobile competition, or a demand for reduction in fares, or both; that they can introduce no further economies of operation; that the rates are as high as the public will pay; that it is impossible to increase revenue by increasing fares, and also, that it is necessary to be ready at all times to meet wage increase; that they are right in applying the income to the rehabilitation of the road, including therein the depreciation which occurred — 131 — during the operation of the Bay State Street Railway Company and the receiver. The master further found that the trustees were men of integrity and business experience who have in large measure left the active management to their chairmen, that the chairmen have been men of experience who have endeavored to manage the Company “for its best good as they saw it.” The plaintiff contends that the trustees are required under the statute to use the earnings of the Company for the payment of dividends as a part of the cost of service, and not to subordinate the payment of dividends “to the creation of an accrued depreciation reserve.” The defendants contend that they have the right to withhold dividends on the ground that the investment value adopted as a basis of capitalization under § 4 was excessive because worthless and depreciated property was therein included at high valuations; that the statute was not intended to deprive them of the necessity of considering the financial condition of the road in all its aspects before deciding that dividends had been earned. The Legislature in providing for the reorganization of the road and creating a new company gave the trustees authority to use their sound discretion and judgment. Their decision on the question of dividends is not to be set aside and the judgment of another tribunal substituted in applying funds to the restoration of the property, if they acted honestly and in good faith, unless their determination was contrary to law. As was said in Boston v. Treasurer & Receiver General, 237 Mass. 403, at pages 417, 418, “Every rational presumption must be made in favor of the decision of men thus appointed. Their conclusion would not be set aside unless unsupported in law.” Mayor & Aldermen of Springfield, petitioners, 234 Mass. 578, 584. As we construe the master’s finding, the trustees acted in good faith. They were required to determine, in the first instance, what property should be abandoned and the extent of rehabilitation necessary. If their decision was in good faith, and was not unreasonable or unsupported by law, it must stand. It was a part of their duty to apply the earnings to the placing of the roadbed and appliances in a safe — 132 — condition. See Thomas v. New York & Greenwood Lake Railway, 139 N. Y. 163. It is not contended by the defendants that the trustees could act as directors in an ordinary corporation and improve the capital value of the Company’s assets before dividends could be said to have been earned. The statute, however, was not intended to deprive the trustees of all discretion in respect to dividends. It was intended that they should act with proper consideration for the interests of the corporation and its creditors as well as for the rights of stockholders, and the Legislature contemplated that the road should continue to be operated as a going concern. See Barnard v. Vermont & Massachusetts Railroad, 7 Allen, 512; Field v. Lamson & Goodnow Manuf. Co. 162 Mass. 388; Fernald v. Frank Ridlon Co. 246 Mass. 64; New York, Lake Erie & Western Railroad v. Nickals, 119 U. S. 296. In the cost of service under § 14, there were included such allowances for depreciation and rehabilitation as the trustees deemed adequate as well as losses from property sold, abandoned or destroyed. And these allowances were not confined to depreciation and losses occurring after June 1, 1919; they included the cost of replacement arising from the rundown condition of the road when they came into possession. The balance between assets and liabilities is not to remain as it stood at the time of incorporation; the statute makes no such declaration, and it is not to be construed that the trustees from the time they took possession are merely to maintain the road in the condition in which it was when they received it, and to pay dividends before the road was restored to a safe and proper condition. These expenses for depreciation were not betterments to be charged to the capital account. They could not properly be capitalized and they were a charge upon the earnings and should be paid for from the earnings. The corporation was not a private concern; it was a public service corporation. The expenditures necessary for the restoration of its property to a proper condition so that it could be operated in safety were in fact operating expenses. Knoxville v. Knoxville Water Co. 212 U. S. 1, 14. Regan v. Farmers’ Loan & Trust — 133 — Co. 154 U. S. 362, 407. Southern Railway v. Carnegie Steel Co. 176 U. S. 257, 288, 289. Although the public service commission under § 4 fixed the investment value of the property for which the Company was to be capitalized, this meant no more than the original cost of the property without deduction for depreciation. The Legislature intended that the property should be operated as a street railway company and it was necessary, if it were to continue so to operate, that its roadbed and appliances should be restored to a proper condition. The Legislature did not contemplate that dividends were to be paid from capital. Section 4 is to be read in connection with § 14, which gives-authority to the trustees to make such allowances for depreciation as they deem adequate, as a part of the cost of service. We find nothing in the report upon which to base a finding for the years 1923 and 1924. There is no fact found to show what amount was charged to operating expenses for these years. It could not be established by “the average of the years 1919 to 1922 inclusive.” Notwithstanding § 8 of the statute, there was no error in the method adopted by the trustees with reference to the reserve fund; § 16 deals with this reserve fund and the trustees had a discretion which was not abused in dealing with it as they did. In the method of accounting followed by the trustees they were dealing with a street railway corporation. They owed a duty to the public as well as to the stockholders, and if in preventing an overcapitalization they acted honestly their conclusion was not in violation of law, and it must stand. The master found that certain reserves for Federal and municipal taxes were unreasonable. In our opinion it was not unreasonable or contrary to law for the trustees to act as they did. These taxes the Company may not be called upon to pay, but there is however no certainty about it. The trustees in the exercise of a wise discretion might properly act as they did. The amount of $16,476.60, carried as a tax liability from 1919, would appear to be excessive, but we do not think that the judgment of the trustees in this — 134 — respect should be set aside. Taking into account the capital invested, the trustees were not required at this time to pay in dividends the amount involved in this item. We find no error in the action of the trustees in reference to the Campello shop item and the Victory Park Extension. The building of the Campello shop was cotemporaneous with the abandonment of another shop. The Victory Park Extension may not add to the value of the property and may not become a betterment. They were not obliged to capitalize these items and might in the exercise of a sound discretion act as they did. The same is true of the Glidden deposit, so called. The settlement of certain demands, we understand, was made after the filing of the supplemental bill, and the trustees may never be called upon to account for all the sums held as a reserve in excess of the amount paid. See Bauer v. International Waste Co. 201 Mass. 197, 203. But in view of the provision of the statute and the discretion given the trustees we do not think that their decision should be reversed. It may probably be that there will be no further obligations in this respect, but this is not certain. With reference to the fire insurance reserve, the judgment of the trustees should prevail, as it does not appear that they acted capriciously or in bad faith. The same can be said of the liability to the United States government for tracks constructed at Fore River. The finding of the master on this item was based on the fact that the Company was to pay the government $317,000 at the rate of. one cent for each passenger carried to and from the Fore River works. The trustees have in effect reduced this liability by more than half by setting up an item of $168,869 on the asset side of their balance sheet. The master found that the sum of $25,000 is sufficient to represent the present worth of this liability. Since the World War, the amount of travel to and from the Fore River works has greatly diminished, and "it probably never again will reach the volume developed under war conditions,” nor can we foresee what may happen to the Fore River works. The trustees may be called upon to pay a much larger sum than $25,000, and we can see no reason why their discretion should be disturbed. — 135 — The master was right in finding as he did that the amount of $608,482.72, representing dividends paid in stock, should be charged to the profit and loss account. The trustees also have properly taken into account the obsolete and abandoned property in dealing with the question of dividends; expenditures necessary to keep the capital intact are operating expenses and are to be paid before dividends are paid. See Kansas City Southern Railway v. United States, 231 U. S. 423, 444, 445. The discretion of the trustees in this matter cannot be said to be unreasonable or in violation of law. There was no error in excluding the testimony offered by the plaintiff bearing on his understanding of the meaning of the vote of the directors. Moreover, the exception which the plaintiff saved before the master was not before this court upon the record. Goodwin v. Cosmopolitan Trust Co. 248 Mass. 146. The defendant’s fourteenth exception is overruled, though the other exceptions of the defendants are sustained. An interlocutory decree is to be entered overruling the plaintiff’s exceptions and the defendants’ fourteenth exception, and sustaining the defendants’ remaining exceptions. A final decree is to be entered dismissing the bill with costs. Ordered accordingly.