Montgomery v. Phillips

The opinion of the court was delivered by Reed, J. On August 14th, 1890, the Capital Cracker Company was-organized with an authorized capital stock of $20,000, divided-into two hundred shares of $100 each. Of this amount of capital stock, $7,500 were subscribed and paid for. The company bought a tract of land, and built a cracker factory upon it.. About January 1st, 1892, the company was reorganized. The-outstanding stock largely changed hands, and its officers wrere changed. All the outstanding seventy-five shares of stock, excepting thirty-four shares held by Herman H. Shellenberger, one-of the original stockholders, was bought up with the money of one Henry D. Phillips. Phillips claims that of the forty-one shares bought with his-money, twenty-three shares were bought for one Sewell. These-three persons — Shellenberger, Phillips and Sewell — held a stockholders’ meeting on January 15th, 1892, and elected themselves-directors, and elected Shellenberger, president and manager, and Phillips, secretary and treasurer. The company at this time was indebted to different persons in-an aggregate sum of $4,300. To pay these liabilities, the company, on January 20th, made a promissory note payable to the-order of Phillips and Shellenberger, for the sum of $4,325,.-which note endorsed by the payees was discounted by the First. National Bank. On March 7th, 1892, Phillips loaned the company the sum of $650. On March 17th, by resolution of the board of directors,' the president was authorized, for the purpose of indemnifying-Phillips against his endorsement of the note, to make a mortgage of the real estate of the company to Phillips; and. for the purpose of securing Phillips for the loan of $650,' the president — 215 — was authorized to execute a mortgage upon the personal property of the company to Phillips. On March 18th, 1892, the real estate mortgage was executed. The chattel mortgage was also executed on the same day, but was never recorded, and so does not figure further in the case. On May 9th following, the company was insolvent. On that day the company assigned its book accounts to the First National Bank, to secure the $4,325 note endorsed by Phillips and Shelienberger. On the same day, the president made a second chattel mortgage to Phillips, to secure the $650 loan. On May 10th, Phillips recorded the real estate mortgage executed on March 18th. On May 23d, Phillips, under his last chattel mortgage, sold the personal property of the company. On June 7th, the complainant, on the bill filed by certain creditors of the corporation, was appointed receiver of the company as an insolvent corporation. The bill prays that the real estate mortgage and the second chattel mortgage made to Phillips, may be set aside, and that Phillips may be compelled to account for the receipts of the sale-of the personal property made under the latter mortgage. It charges that the assignment of the book accounts to the First National Bank was fraudulent, and in fact, that the books never went from Phillips’ possession, but that he has collected the-accounts; that the bank has disclaimed any claim to the said' books. The prayer of the bill is that Phillips may account for-the sums he has so collected. The bill also charges that Phillips employed one Robert-Green and paid him $20 per week, with the understanding that this should be charged up to the company, while Green -was to-repay $10 each week to Phillips. There is also a prayer that he account for these $10 weekly receipts. I will consider the subjects involved in the litigation in an order inversely to that in which they -were just stated. In respect to the claim that Phillips personally received and held a portion of the wages of Green, charged up to the company, I think the complainant has made no case. Phillips says that Green was not able to do his work, and that he, Phillips, — 216 — was compelled to get other employes to do a portion of it, and the money was retained on this account, and has, as I understand it, been used for corporation purposes; at least, the misapplication of corporate money is not proved with any degree of certainty. In respect to the assignment of the book accounts to the bank, I also think it has not been successfully attacked. The line of assault contained in the bill is not sustained by proof. "While the books did technically remain in the hands of Phillips, the undisputed testimony is that the assignment was made to the bank and the books were submitted to the bank officers; that the bills were collected, with the approval of the bank, in the name of the solicitor of the bank; the moneys received from them were paid to Phillips, who deposited the money in the bank, to be applied to the payment of the note. While the payment of the money to Phillips has an air of oddity, yet no one is called to contradict the statement that the assignment was presented to the bank, and that the money was .subsequently collected for and was paid to the bank, to be applied to the payment of this note. The attack upon the assignment, made upon the argument, was put upon another ground, namely, that Sewell was not a legal director, and so there was no board existing qualified to make the assignment. But whether Sewell was or was not a de jure director, he was admittedly a de facto director. In respect to the bank, which was a third party, with no notice of the defect, if any existed, in his eligibility, the assignment was entirely efficacious. ■ The next attack is upon the chattel mortgage, by color of which Phillips sold the personal property. This mortgage was, as I have already remarked, executed on May 9th, 1892. At that time the corporation was insolvent. The mortgage was made to secure the antecedent liability of Phillips, as endorser for the benefit of the company. The mooted validity of this mortgage involves the question whether the board of directors of an insolvent corporation can secure one of their own members for an antecedent debt by a mortgage of the property of the company. The question is new in this court. — 217 — It was held in the. ease of Wilkinson v. Bauerle, 14 Stew Eq. 635, that an insolvent corporation could sell its property to a director if the sale was bona fide and brought the full value of the property. It was held that the officers of such corporation could not divert the corporate property from the payment of its debts, and it was because such a sale was only a transmutation, and not a diversion of the property, that the sale was sustained. It was also held in Vail v. Jameson, 14 Stew. Eq. 648, that a mortgage made by an insolvent corporation for the purpose of preferring a creditor was not invalid. The great weight of authority is, however, opposed to the existence of any power in a board of directors of an insolvent company to prefer one of its own members. The weight of authority is in support of the wholesome rule that the directors of an insolvent corporation are trustees of its funds for its creditors. Curran v. State of Arkansas, 15 How. 307; Haywood, et al. v. The Lincoln Lumber Co., 64 Wis. 639; Wilkinson v. Bauerle, 14 Stew. Eq. 635. The doctrine in respect to the power of trustees to use trust property for their own benefit to the disadvantage of their cestuis que trust thus becomes applicable to the dealing of directors with the funds in their hands, after the insolvency of the corporation.' If any of such directors are creditors, they stand upon the same footing as any other creditors; but by no act of such director can he obtain a position superior to that of the other creditors for whose benefit he holds the trust assets. Mr. Morawetz remarks: “ It is the duty of the directors, or other agents of insolvent corporations, to preserve its assets for the benefit of the creditors. The legal ownership of the assets is not altered by its insolvency, and the regular agents of the corporation retain the same powers of management with which they were originally invested. But upon the insolvency of a corporation, an equitable lien of the creditors attaches upon all the company’s assets; and the directors who only formerly stood in a fiduciary relation to the corporate members, become placed in a fiduciary relation to its creditors. * * * If themselves ■creditors, they cannot receive any advantage or preference in the payment of .their claims at the expense of other creditors.” Morawetz Corp. § 579. Iu Haywood et al. v. The Lincoln Lumber Co. et al., supra, a mortgage had been made by an insolvent company to some of — 218 — the directors, to secure an antecedent debt. The mortgagee filed a bill to foreclose the mortgage, which suit was defended by the receiver of the corporation. The court, in holding that the mortgage was void, employed this language: “ The directors and officers made the mortgage, or directly caused it to be made, to-themselves. They occupied a fiduciary relation to the company,, its stockholders and its creditors, and they had no right to use such relation and their official position for their own benefit, and to the injury of others in equal right. In Beach v. Miller, 130 Ill. 162, the question arose whether an insolvent company could secure an antecedent debt due a director by a sale to him of ils property to pay such debt. The court remarked that so long as-a -corpojation .remained solvent, its directors were agents or trustees for the stockholders; but the moment it became insolvent,, its directors occupied a different relation. The assets must then be regarded as a trust fund for the payment, of all its creditors, and the directors occupy the position of trustees, and the fiduciary relation then existing, they may, with propriety, be prohibited from purchasing the trust property.” The court was speaking in view of the fact that the purchase-was to be paid for by the application of the precedent credit held' by the director. In Richards v. New Hampshire Insurance Co., 43 N. H. 263, on a bill filed by the creditors of an insolvent company, it was held that the directors were trustees of the funds for the creditors,, and were bound to apply them pro rata, and could not use them, to exonerate themselves to the injury of other creditors. All the cases bearing upon this question are collected by Mr. Justice Woods in his opinion in the case of Lippincott et al. v. Shaw Carriage Co. et al., 25 Fed. Rep. 577, 586. He very carefully states the rule to be derived from these cases in these words: “ It has been often said by judges, including those of the federal supreme court, that the property of an insolvent company is a trust fund, and that the directors are trustees for the creditors; and if this were strictly "so, it is manifest that no preference whatever should be allowed between creditors standing in the same relation to the fund. These statements are,. — 219 — however, true in a qualified sense, and lead legally, if not necessarily, to the conclusion that in such cases, the directors, if they give preferences, must do it unbiased by considerations of personal advantage or gain.” I regard this as a salutary rule, grounded upon .general equitable principles. This view invalidates the chattel mortgage-executed on May 9th, to Phillips, as mortgagee. Lastly, in respect to the real estate mortgage made to Phillips to secure him for his endorsement. It appears that this mortgage was authorized by the board of directors on March 17th, and was executed on March 18th, and was recorded May 10th. If it was delivered at the time it was executed, it would not be invalidated by the rule just applied to the chattel mortgage of May 9 th. The bill states that the company was insolvent on May 9th, therefore, upon the pleadings, the real estate mortgage was executed while the company was still solvent.' What became of this mortgage after it was executed does not appear. There is no allusion in the pleadings nor in the evidence to the custody of this instrument, from the date of its execution to the time of its registration. How I think that some evidence should have been produced to show that the mortgage was actually delivered, and so became an executed contract between the company and Phillips before the day it was recorded. But aside from this view of the legality of that instrument, I think there is another aspect in which it is defective, when, as now, attacked by the representative of the creditors. The mortgage, as I have already remarked,'was kept from record until after the company became insolvent. The bill charges, and the charge is not denied, that all the debts were contracted between the date of the execution and the date of recording the mortgage. How, it is admitted that the mere failure to record a mortgage is not in itself a conclusive reason for setting it aside for the benefit of 'subsequent creditors having no specific liens, but that any'concealment of an instrument of this kind is a badge of — 220 — fraud, which may, by reason of the circumstances surrounding the concealment, be sufficient ground for avoiding such an instrument in respect to subsequent creditors, is entirely settled. In Hungerford v. Earle, 2 Vern. 261, it was held that a deed, not at first fradulent, may afterward become so by being concealed or not pursued, by which means creditors are drawn in to lend their money. The failure to record a deed or mortgage when there is no apparent change of possession, has been held in a number of cases to be a strong circumstance against the validity of such instrument when it was attacked by the creditors, who become such intervening the time of its execution and the time of its record. Coates v. Gerlach, 44 Pa. St. 43; Gill v. Griffith, 2 Md. Ch. 270; Hilliard v. Cagle, 46 Miss. 309; Neslon v. Wells, 104 U. S. 428; Blennerhassett et al. v. Sherman, 105 U. S. 100. Now, in respect to the circumstances surrounding the execution of the present mortgage, the evidence is very strong that ■at the time this instrument was executed Shellenberger and Phillips held all the outstanding stock of the corporation. The shares ostensibly held by Sewell were bought with Phillips’ money, and although Phillips claims that there was an understanding that Sewell was to repay him, the conduct of both Phillips and Sewell is very persuasive that Phillips was to practically control the stock, and that the transfer of it to Sewell was for the mere purpose of equipping him with the nominal character of stockholder, so that he could be elected to constitute the required third director. Phillips was an active agent in resuscitating the moribund corporation. He and Shellenberger were, in fact, the corporation. They had made, as the corporation, and both individually endorsed, the promissory note, by the discount of which the debts of the company, including a debt to Phillips himself, were paid. The real estate mortgage was made to secure Phillips against his liability upon this note, and incidentally to secure Shellenberger also. The original chattel mortgage was to secure Phillips for the additional advance of $650. The future financial success of the company was, in the light of its past failure, problematical. — 221 — If it should succeed, there would be no use for the two mortgages ; if it should fail, then they were to he resorted 'to for indemnity. The experiment was to be made at the risk of future creditors. Eor the purpose of leaving the credit of the company unimpaired, the mortgages were kept from record. When insolvency came, it was too late to record the chattel mortgage, so-the real estate mortgage only was registered. I have no doubt from the testimony that these were the motives which induced the delay. When it is kept in mind that Phillips was the active officer for the corporation who caused the. execution of the mortgage, as well as the mortgagee for whose benefit it was made, the whole arrangement was equivalent to. an agreement between the parties, mortgagor and mortgagee, to keep the mortgage from record for the purpose of sustaining the-credit of the company by concealing its existence. Under these circumstances, I think the mortgage must be regarded as made to hinder and delay creditors, and so held to be fraudulent. The decree of the court of chancery should be reversed, and a decree made in conformity with the views herein expressed. For reversal — Depue, Dixon, Garrison, Lippincott, Reed, Van Syckel, Bogert, Brown, Sims — 9. For affirmance — None.