Frishmuth v. Farmers' Loan & Trust. Co.

SHIPMAN, Circuit Judge (after stating the facts as above). The .circuit judge was of the opinion that the bill stated a good cause of action, and overruled the first demurrer. The grounds upon which he rested his conclusion were that the duties of the defendant, which was a trustee for the benefit of the bondholders, were not simply those which were stated in terms in the mortgage, but were imposed upon and were assumed by the defendant by the fact of trusteeship, and by the situation or obvious nature of the mortgage security. Tn this case— . - .“The. security was practically in nubibus at the inception of the trust, and was to be created by the co-operation of the defendant and the Oregon Company. It was to be constituted an adequate security by the acquisition of property by ttie Oregon Company through the proceeds of the bonds to be Issued by the trustee. The mortgage was sedulously framed and expressed to Induce investors to purchase the bonds upon the faith that such property would be acquired with the proceeds, and that as the bonds were issued by the trustee the proceeds would be devoted by the Oregon Company, under the supervision of the' trustee, to feed the security and satisfy the promises set forth in the bonds and in the mortgage covenants. The statement in the bonds that the issue was to be limited to $25,000 per mile of railroad was a promise by the Oregon Company that there should be a mile of completed railroad for every $25,000 of bonds issued. This statement, and also the covenant in respect to the application of the proceeds of the first bonds to be issued, were obviously inserted to assure investors that the security would .be adequately augmented concurrently with the issue of the bonds. The only, possible object of the provision restricting the trustee from delivering the bonds or their proceeds to the Oregon Company, except on orders declaring the purposes for which they were to be used, was to satisfy the investors that the trustee was to supervise the operations of the Oregon Company in respect to the purposes to which it intended to make application •of the proceeds, and thus effectuate the promises of that company. The several'provisions imply the power- and the duty of the trustee to refuse to issue bonds except when supplied with evidence that the avails are to be used' conformably with the promises of the Oregon Company, The defendant •cannot escape responsibility to those who have bought the bonds upon the theory that the' mortgage does not contain any covenants by the trustee prescribing its conduct .except-in the event of a' default in payment..' They are [173] entitled to liold the defendant to the performance of the duties which, from the import of the provisions, they had a right to suppose the trustee would perform. While its terms exonerate the trustee for a misapplication after it has delivered the bonds or proceeds to the Oregon Company upon orders of the requisite character, they do not absolve it further. They certainly do not protect the trustee in delivering bonds or proceeds which it knows or has reason to believe are not to be applied properly. The instrument is not to be construed as authorizing- the trustee to deliver the bonds or their proceeds upon orders containing such vague and indefinite declarations as were inserted in those given by the Oregon Company. Upon such a construction the provision conferring authority would afford no security for the bondholders, and would be a mere sham. It was intended to restrict the trustee from delivering bonds or proceeds without information of the specific uses to which, from time to time, they were being applied, in order to enable the trustee to ascertain whether they were being expended conformably to the promises of the Oregon Company.” The third demurrer was sustained because the action was brought in the name of the complainants alone, — a defect which was subsequently cured by amendment. The fourth and fifth demurrers, that the suit was barred by the statutes of limitations, were sustained because the entire issue of bonds bad been delivered by the defendant in June, 1885, 14-J years before the commencement of the action; and, while courts, of equity of the United States are not subject to restriction by state statutes, they feel themselves bound, in cases of concurrent jurisdiction, to act in analogy to those statutes. The sixth and seventh demurrers, which set up the defense of laches, were overruled. Judgment was ordered sustaining the third, fourth, and fifth demurrers, and overruling all the others and dismissing the bill unless the - complainants saw fit by amendment to obviate the objections. The complainants thereupon amended by adding to the original bill averments that the same acts in regard to certification which bad been previously stated were fraudulent, that the certification of the bonds was to enable the Oregon Eailroad Company to perpetrate a fraud, and averred the ignorance of the fraud by the complainants and its concealment. The defendant thereupon renewed, in substance, its demurrers; and the circuit court adhered to its original position upon the ground that if the cause was, as before, for the breaches of duty by the defendant, the statute of limitations would defeat the action, but,, if the amendment turned the bill into one for fraud, it stated a cause of action which was not common to all the bondholders. The complainants in the Frishmuth Case treat the amendment as immaterial, and as simply asserting that, the acts of the defendant constituted a legal fraud, without changing the cause of action, which was for a breach of covenant, and urge that the decision upon the original bill was erroneous. If the complainants had wished a. review of that decree, they should have omitted to amend the bill by the averment in regard to fraud, and should have taken an appeal from the judgment, which sustained the demurrers. U. S. v. Boyd, 5 How. 29, 12 L. Ed. 36; Jones v. Thompson, 6 Hill, 621. But, as the complainant is urgent upon the question that the bill as amended is an action upon a. sealed instrument for the breach of covenants therein, and therefore the cause of action is not> barred, except by analogy to. the statute, which prescribed a liiui [174] tatión'of 20 years, and as the amendment was confessedly immaterial, we will look into the question of the cause of action. It is clear that the mortgage contained no express covenant against neglect of duty by the trustee. Neither can any implied covenants to that effect be read into its terms. The defendant signed the mortgage and attached its corporate seal for the purpose of expressing its acceptance of the trust. The law imposes upon a trustee the duty of fidelity to the pecuniary interests of the cestuis que trustent, and the necessity for fidelity is measured somewhat by the situation of the trust fund. In the case of this mortgage, as the security was “practically in nubibus,” it was the duty of the trustee to see that new bonds were not carelessly and improvidently issued upon vague declarations of the purposes to which they were to be applied. This duty was imposed by law from the fact of trusteeship, and was not imposed by covenant. The omission to discharge the obligation was a breach of duty, and may be regarded as a breach of a quasi contract, or contract implied by law. A covenant tó discharge the duty was not one which would naturally be inserted in a mortgage between a mortgagor and a trustee, and ought not to be inserted by implication unless clearly growing out of the language or the obvious intent of the parties. In the Antelo Case it is not claimed that the liability of the. defendant was for the losses sustained by a breach of covenant, but was for the losses sustained by a breach of its duty. The acts of the trustee which are complained of with respect to the certification of the bonds are the same as in the FrishmuthCase, but the Antelo bill avers that the right to acquire the 850,000 acres existed until the fall of 1894, when it was lost by the neglect of the trustee to defend against a suit to declare the forfeiture of the right. Altschul v. Hogg (C. C.) 62 Fed. 539. The same disposition was made of the several demurrers as was made in the Frishmuth Case, except as to the second, which alleged a defect of parties complainant, — a defect which did not' exist in the Antelo bill. The complainants thereupon amended, not by changing the original bill, but adding to it averments which were, in substance, those of the amendment in the Frishmuth suit, and that the fraud was concealed until within six years before suit was brought; the object being to bring the case within the rule of the United States courts that, where an action is brought in equity .to recover on the ground of actual concealed fraud, “time will not begin to run in favor of the defendant until the discovery of the fraud, or until with reasonable diligence it might have been discovered.” Kirby v. Railroad Co., 120 U. S. 130, 7 Sup. Ct. 430, 30 L. Ed. 569. If, as in the Frishmuth Case, the appellant had wished to challenge the correctness of the decree which dismissed the original bill, he should have appealed from that decree. U..S. v. Boyd, supra. '-.The questions of importance which are before the court upon this appeal are whether the grounds of demurrer have been removed by the amendment; that is, whether the cause of action,, as. now stated by the bill-as amended; is one for fraud, or,; as before, for a breach of duty, and, if for fraud, whát are the consequences. . Is .it á good'bill, or is it multifarious (the defendant having made multifariousness an additional-ground .of demurrer), or was the [175] injury remediable only by an action at law? The fundamental question is, what is the cause of action as stated in the bill? The appellant makes an additional point in regard to the form of the decree, — that it did not state, as it should have done, the causes of demurrer which were allowed and disallowed. The decree upon the original bill disallowed all the causes of demurrer, except those relating to the statute of limitations; and the opinion of the circuit judge upon the demurrers to the amended bill shows that, in his opinion, the question before him was upon the effect of the amendment. There is no practical difficulty in knowing which of the demurrers were sustained. The amendment consisted in characterizing the certification of the bonds as fraudulent, and adds to the previous averments of negligence the word “fraudulent.” It is apparent, and it is conceded by the appellee, that the gravamen of the bill is still violation of duty, and that there was no intention to change the cause of action, which originally was for relief from the breach of trust by the trastee in certifying bonds which did not have the requisite security, and therefore were fraudulent in their nature. The original bill and the amendment contain a single set of facts, and the prayer of the bill as amended is for payment of the bonds, which have become worthless by the negligent conduct of the trustee. When the gravamen of the bill is for a breach of duty, and the action is thereby brought within the adverse effect of the influence of the statute of limitations, the addition of bare averments which call the same acts fraudulent do not convert it into a bill both for a fraud and a breach of duty or for fraud alone. The alleged acts constituted negligence, and it is useless to escape from the legal consequences of an action to recover damages for such acts by affixing to them the adjective “fraudulent.” The bill is what it was originally, and the rider in regard to fraud has not altered its character. The counsel for the complainant is of the opinion that sufficient attention was not paid by the circuit judge to the allegations of negligence on the part of the defendant in not defending in 1894 against, the suit in Oregon for the forfeiture of the right of the railroad company to 850.000 acres of land, whereby a decree of court was entered which involved an alleged loss to the bondholders of fS,000,000. The circuit judge did not apparently hold that a recovery for the consequences of this alleged negligence was barred by lapse of time, but was of opinion that no sufficient acts of negligence were averred in the bill, for it does not appear that there was a defense, or that the right had not long before the commencement of the suit been lost. We think that the bill was and is deficient in that respect. The decrees of the circuit court in each suit are affirmed, with costs of this court.