Hanna v. State Trust Co.

CALDWELL, Circuit Judge, after stating the case as above, delivered the opinion of the court. The precise question in this case is whether a court of chancery which has appointed a receiver for an insolvent private corporation in a foreclosure suit brought by a second mortgagee may, against the objection of the first mortgagee, authorize its receiver to issue receivers certificates to raise money to carry on the business of the insolvent corporation and to improve its lands, and mala1 such certificates a first and paramount lien upon the lands covered by the lire! mortgage. Co far as we are advised, the power to do this has been denied in every case in which- the question has arisen. One of the first cases in which- the question arose was Raht v. Attrill, 103 N. Y. 423, 13 N. E. 282. In that case a hotel company mortgaged its properly to raise funds to build a hotel. Before the completion of ihe hotel the corporation became insolvent, and upon ihe application of its principal stockholder a receiver ivas appointed; and upon an application and showing that; the wages of the men who worked on ihe hoi el building were unpaid, and that they threatened, unless paid, to burn the building, the court made an order authorizing the receiver 1o issue certificates, which were declared to be a Hen prior to the trust mortgage, to raise funds to pay the wages due the laborers. A referee reported that, if the money lia.d not been raised to pay the wages due the men, the hotel and other property of the corporation “would, in all probability, have been destroyed or seriously injured,” In ihe progress of the case the mortgagee denied that the court had authority or power to set aside the prior lien of the mortgage and make the receiver’s, certificates, issued under the circumstances mentioned, a first and prior lien upon the property. The court delivered an exhaustive opinion, covering every aspect of the question. We quote some of its utterances. The court, said: ‘The lien of the mortgage citadles, not only to (he land in the condition, in which it was at 1lie time oí the execution of the mortgage, but as changed or improved by accretions or by labor expended upon it. while the mortgage is; in existence. Creditors having debits created for money, labor, or materials used in improving the mortgaged property acquire on that account no legal or equitable claim to displace or subordinate the lien of the mortgage, for ¡heir proieelion. * ⅜ * The act of the court in taking charge of prop-eri.v through a receiver is attended with certain necessary expenses of its care and custody; and it has become the settled rule that expenses of reali [6] zation, and also certain expenses wliicii are called ‘expenses of preservation, ’ may be incurred, under the order of the court, on the credit of the property; and it follows, from necessity, in order to the effectual administration of the trust assumed by the court, that these expenses should-be paid out of the income, or,' when necessary, out of the corpus, of the property, before distribution, or before the court passes over the property to those adjudged to be entitled. * ⅜ * It would be difficult to define, by a rule applicable in every case, what are expenses of preservation which may be incurred by a receiver by authority of the court. It was said by James, L. J., in Re Regent’s Canal Iron-Works Co., 3 Ch. Div. 411, 427, that ‘the only costs for the preservation of the property would be such things as the repairing of the property, paying rates and taxes which would be necessary to prevent any forfeiture, or putting a person in to take care of the property.’ Where-ever the true limit is, we think it does not include the expenditure authorized by the order of August 17th, and that such an expenditure is, and ought to be, excluded from the definition. There must be something approaching a demonstrable necessity, to justify such an infringement of the rights of the mortgagees as was attempted in this case.” After referring to the cases in which the receivers of insolvent railroad corporations have been authorized to issue certificates which were declared to be a first lien on the property of the corporations, the court said: “It cannot be successfully denied that the decisions in these cases vest in the courts a very broad and comprehensive jurisdiction over insolvent railroad corporations and their property. It will be found, on examining these cases, that the jurisdiction asserted by the court therein is largely based upon the public character of railroad corporations, the public interest in their continued and successful operation, the peculiar character and terms of railroad mortgages, and upon other special grounds, not applicable to ordinary private corporations. ⅜ ⅜ ⅞ These cases furnish, we think, no authority for upholding the order of August 17th, or for subverting the priority of lien which, according to. the general rules of law, the bondholders acquired through the trust mortgage on the property of the company. It would be unwise, we think, to extend the power of the court in dealing with property in the hands of receivers to the practical subversion or destruction of vested interests, as would be the case in this instance if the order of August 17th should be sustained. It is best for all that the integrity of contracts should be strictly guarded and maintained, and that a rigid, rather than a liberal, construction of the power of the court to subject property in the hands of receivers to charges, to the prejudice of creditors, should be adopted.” We concur in the doctrine expressed in this case. See, to the same effect, Farmers’ Loan & Trust Co. v. Grape Creek Coal Co., 50 Fed. 481; Laughlin v. Rolling-Stock Co., 64 Fed. 25; Fidelity Ins., Trust & Safe-Deposit Co. v. Roanoke Iron Co., 68 Fed. 623; Snively v. Coal Co., 69 Fed. 204; and Hooper v. Trust Co. (Md.) 32 Atl. 505, 513. The contention of the appellees is that the order made by the circuit court finds sanction in the cases of Wallace v. Loomis, 97 U. S. 146; Fosdick v. Schall, 99 U. S. 235; Barton v. Barbour, 104 U. S. 126; Miltenberger v. Railroad Co., 106 U. S. 286, 1 Sup. Ct. 140; Trust Co. v. Souther, 107 U. S. 591, 2 Sup. Ct. 295, — and other later cases of like character, in which receivers of insolvent railroad corporations were authorized to issue receivers’ certificates for various purposes, which were made a first and paramount lien on the property of the insolvent railroad company.' But the doctrine of these cases has no application to this case. They rest on the peculiar character of railroad [7] property and of a railroad corporation. The distinction between railroad corporations, which are of a quasi public character, and purely private corporations, has been often pointed out, and need not be repeated here. It is enough to say that the supreme court itself has said that the doctrine of tlu* cases cited has only been applied in railroad cases. In Wood v. Safe-Deposit Co., 128 U. S. 416, 9 Sup. Ct. 131, the court said: “The doctrine of Fosdick v. Schall lias never yet been applied in any case except that of a railroad. The case lays great emphasis upon tlie consideration that a railroad is a peculiar property, of a public nature, and discharging' a great public vor¿ There is a broad distinction between such a case and that of a purely private concern. We do not undertake to decide the question here, but only point it out.” The bill in this case is one to foreclose a second mortgage. To such a bill the prior mortgagees are not even necessary parties. Jerome v. McCarter, 94 U. S. 734. The validity and priority of tlie liens of the mortgages under which the appellants claimed is distinctly admitted in the original and amended bills. The purpose of filing the amended bill making the prior mortgagees defendants seems to have been to enjoin them from foreclosing their mortgages, and subject the lands covered by their mortgages to a prior lien for money borrowed to carry on the business of the corporation and improve its lands. It prays that the receiver may be empowered to manage and operate the property of tlie insolvent corporation, which consists in irrigating, improving, and colonizing, or settling, arid lands; and, to the end that the receiver may not be interfered with in the conduct of the business, it prays that the holders of all mortgages prior to the complainants’ may be enjoined from foreclosing tbe same. The amended bill would seem to be founded on the theory that a private corporation conducting any kind of business may, when it becomes insolvent, obtain immunity from the compulsory payment of its debts by procuring a junior mortgagee, or some other creditor, to tile a bill alleging the insolvency of the corporation, and praying for the appointment of a receiver with authority to manage and conduct its business. Upon the filing of such a bill, it is supposed to be competent for the court, in addition to appointing a receiver to carry on the business of the corporation, to enjoin its creditors, including* the holders of the prior liens on its property, from collecting their debts by due course of law, and to continué such injunction in force so long as the court, in its discretion, sees fit to carry on tlie business of the insolvent corporation. When a receiver is appointed uniter such a bill, he usually makes liaste, as the receiver did in this case, to assure the court that, if lie only had some capital to start on, he could greatly benefit the estate by earning on the business that bankrupted the corporation. In this case, the company being insolvent, and its property mortgaged for more than it was worth, there was no way of raising money to set the receiver up in business, except by the court giving its obligations, in tbe form of receiver’s certificates, and making them a paramount lien on all the property of the corporation, by displacing the appellants’ prior liens thereon. As commonly happens in cases of this character, the receiver, the insolvent corporation, [8] and the junior mortgagee united in urging the court to arm its receiver with the desired powers. They ran no risk in so doing. The corporation was insolvent, and a foreclosure of the prior mortgage would leave the junior mortgagee without any security; so that it had nothing to lose, and everything to gain, in experiments to enhance the value of the mortgaged property, so long as the cost of those experiments was made a prior lien thereon. The effect of the proceeding was to burden the prior mortgagee with the whole cost of the expenditures and experiments made for the betterment of the property on the petition, and for the benefit of the insolvent corporation and the junior mortgagee. The representation is always made, in such cases, that the receiver can carry on the business much more successfully than was done by the insolvent corporation. This commonly proves to be an error. Raht v. Attrill, 106 N. Y. 430, 13 N. E. 282. But, if it were true, it would afford no ground of equitable jurisdiction, for it is not a function of a court of equity to carry on the business of private corporations, whether solvent or insolvent. It is obvious that if the holders of the first mortgages and the other creditors of the insolvent corporation were allowed to proceed, in the customary and lawful mode, to collect their debts, it would put an end to the business of the receiver, and they are therefore enjoined from foreclosing their mortgages or collecting' their debts. The chancery court thus assumes, in effect, all the powers and jurisdiction of a court of, bankruptcy or insolvency, but without any bankrupt or insolvent law to guide or direct it in the administration of the estate. Its only guide is that varying and unknown quantity called “judicial discretion.” The powers claimed for a court of equity in such cases are, indeed, much greater than a court of bankruptcy can exercise. There never was a bankrupt court, under any bankrupt act, authorized, at its discretion, to displace or nullify valid liens on the bankrupt’s property, or itself to create liens paramount thereto. The rights of the citizen, lawfully acquired by contract, are under the protection of the constitution of the United States, and, like the absolute rights of the citizen, are not dependent for their existence or continuance upon the discretion of any court whatever. Constitutional rights and obligations are no more dependent on the discretion of the chancellor than they are on the discretion of the legislature. “Bights,” says the supreme court of the United States, “under our system of law and procedure, do not rest in the discretionary authority of any officer, judicial or otherwise.” In re Parker, 131 U. S. 221, 9 Sup. Ct. 708. If júnior lien creditors of an insolvent private corporation could do what has been attempted in this case, every private corporation operating a sawmill, gristmill, mine, -factory, hotel, elevator, irrigating ditches, or carrying on any other business pursuit, would speedily seek the protection of a chancery court, and those courts would soon be conducting the business pf all the insolvent private corporations in the country. If it were once settled that a chancery court, through- a receiver appointed on the petition of a junior mortgagee, could carry on the business of such insolvent corporations at the risk and expense of those holding the first or prior liens on the property of the corporation, such liens would have [9] little or no value. It is no part of the duty of a court of equity to conduct the business of insolvent private corporations, any more than it is to carry on the business of insolvent, natural persons, if it may take under its control the property of an insolvent private corporation, and authorize a receiver to carry on its business, and make the debts incurred by the receiver in so doing paramount liens on all the property of the corporation, and enjoin its creditors in the meantime from collecting their debts, it is not perceived why it may not proceed in the same way with the estate of an insolvent natural person. Without pursuing the subject further, we refer to what is said, and to the cases cited, in Scott v. Trust Co., 69 Fed. 17. The order appealed from is void, whether the suit in which it was made is treated as one to foreclose a second mortgage, or as a bill in equity to administer the estate of an insolvent corporation. It was open to the complainant to take and execute a decree foreclosing its second mortgage, and it is good practice in such cases to require this to be done, on pain of dismissing the bill. And if the complainant desired chat money be spent, beyond (he income of the property, in carrying on the business of the corporation or improving the mortgaged property, it was at liberty to furnish the means for that purpose; but it had no equity to ask that the expense and the hazards of doing so should be saddled on the first mortgagee, and the court had no jurisdiction or power to place it there. Taxes are the first and paramount lien on all property, and must be paid. When taxes are due on property in the hands of a receiver, and he has no funds to pay them, the court will authorize him to borrow money for that purpose, and make the obliga!ion given for the money so (borrowed a prior lien on the property on which the taxes were due. This is not fixing a new or additional lien on the property, or displacing any prior lien. It is simply changing the form of the lien from one for taxes to one for money borrowed to pay the taxes. The order and decree of the circuit court appealed from, which authorizes the receiver to borrow money to “be used and applied by said receiver for the purpose of preserving the property of the Denver Land & Water Storage Company in his possession and custody, and carrying out and maintaining the contracts of the company, now in existence, under and by which the company has heretofore sold tracts of land to various parties, which said contracts are referred to in the report of said receiver, and for such other purposes as are set out in said petition with reference to the maintenance, preservation, and protection of the property of the company,” and which authorizes the receiver to issue liis certificates of indebtedness for the money borrowed for these purposes, and makes such certificates of indebtedness the first and paramount lien “upon all the property, rights, and franchises now owned or controlled by the said the Denver Land & Water-Storage Company,” is void, in so far as it makes the certificates issued by the receiver a first and paramount lien on the lands embraced in the mortgages of the appellants, and is therefore reversed.