Farmers' Loan & Trust Co. v. Toledo, A. A. & N. M. Ry. Co.

TAFT, Circuit Judge (after stating the facts). The petition is undoubtedly defective in this: that it does not show that any attempt has been made to procure the board of directors to make the defenses for the company which the petitioners ask to be allowed to make. The averments of the petition with reference to collusion aifect but four of the eleven directors, and it does not appear affirmatively that the oilier seven directors would not, if requested, make the defenses which the petitioners propose to set up. But, if there is a valid and equitable defense to the claim of §1,443,000 against the defendant company, which the directors have failed to make in an action for foreclosure, which will in all probability obliterate all interest that the holders of 65,000 shares of the capital stock of the defendant company have in the property, the court, though it might be obliged to dismiss the petition for the objections urged to it, would certainly give the petitioners an opportunity to apply to the board of directors, and, on their failing to make the defense, would then allow the petitioners to intervene to make it. The refusal of the board of directors to make a valid and equitable defense to the foreclosure of the mortgage, and a sale of all the franchises and property belonging to the road, wTben the existence of such a defense is brought to their knowledge, would of itself constitute such gross neglect or fraud on their part as to require the court t o permit their interested cestuis que trustent, the stockholders, to make the defense themselves. Dodge v. Woolsev, 18 How. 331. We therefore find it necessary to proceed to the consideration of the defenses proposed to be made and their validity. Before doing so, however, we should observe that the averments in the petition with reference to the two plans of reorganization have no relevancy whatever to the question before the court except as evidence to enforce the charge against four of the directors that they are interested as bondholders not to make the defenses for the company which, as directors, it would be their duty to make. With the fairness and equity of the reorganization plans the court has nothing to do. Any person, or any number of persons, may purchase the road at the public sale. If the bondholders choose to buy in the road to protect their security, there is no obligation upon them whatever to divide the benefit of their purchase with — 54 — the stockholders. If the stockholders are of opinion that the road exceeds in value the debts which rest upon it, they are at liberty to bid such a sum for the road as will pay the debts and will leave a surplus for division among themselves upon their stock. In no other way can they secure action by the court to assist them in obtaining value for their stock. We come now to the defenses which the petitioners propose to set up. The first is that the defendant company is not a legally incorporated company of Ohio. The averment of the amendment to the petition is that in February, 1888, “there was in existence another corporation, having the same name as the defendant, and owning a railroad from Toledo, Ohio, to Mt. Pleasant, Mich., And another corporation, known as the Toledo, Ann Arbor & Cadillac Railway Company owning a railroad from Cadillac, Mich., to Mt. Pleasant, Mich., both of said roads being parts of the railroad sought to be mortgaged under said consolidated mortgage, and described therein; and that on the 27th day of February, 1888, the boards of directors of said first-named corporation, and on the 29th day of February the board of directors of said last-named corporation, at meetings held by said boards respectively, adopted resolutions approving an agreement for consolidation, previously executed by three directors of each of said corporations for said corporations, respectively, but without any previous authority of either of said boards; that meetings of stockholders of said two corporations were held on the same day of the meeting of directors at which only a part of the stockholders of said respective corporations were present in person or by proxy, at which meetings resolutions were adopted purporting to approve of said agreement; that, as your petitioners are informed and believe, no notice, as required by law, was given of said stockholders' meetings of either of said corporations, and that it was impossible to give such notice between the time when said meetings of directors were held and when said meetings of stockholders were held, both directors and stockholders having met upon the same day; that, as your petitioners are informed and believe, said agreement was filed in the office of the secretary of state of the state of Michigan, but the same has never been filed in the state of Ohio, and that no effort was made to conform to the laws of Ohio regulating the consolidation of railway companies, and that no consolidation was effected or attempted to be effected of said companies, except as herein-before stated; and that said consolidated mortgage is not, therefore, a lien upon any part of said railroad.” Section 3380 of the Revised Statutes of Ohio permits a railway company organized in that state to consolidate its capital stock with the capital stock of another company in an adjoining state, organized for a like purpose, where their roads, united and constructed, will form a continuous line for the passage of cars. Section 3381 prescribes the conditions and restrictions for such consolidation. First, the directors of the two companies are to enter into a joint agreement, describing the terns thereof with all the details necessary to — 55 — procure the new organization and consolidation. Second, the agreement is to be submitted to the stockholders at a meeting called separately for the purpose of taking the same into consideration, and due notice of the time' and place of such meeting and the object is to be given by written or printed notices, addressed to each of the registered stockholders, and by a like notice published in a newspaper where the company has its principal office; "provided, that in case ail the stockholders are'present at such meeting, in person or by proxy, such notice may be waived in writing.” A vote is required to be taken upon the question of the consolidation under the agreement, and if two-thirds of all the votes cast at the meeting be for the adoption of the agreement, the fact has to fee certified by the secretary of each of the companies, and these certificates, together with a certified copy of the agreement, must be filed in the office of the secretary of state. Section 3382 provides: “When the agreement Is made and perfected, as provided in the preceding section, and the same or a copy thereof filed with the secretary of state, tlio several companies parties thereto shall be deemed and taken to be one company, possessing within this state all the rights, privileges and franchises, and subject to all the restrictions, disabilities and duties oí a railroad company.” It is to be presumed, in the absence of an averment to the contrary in the petition, that the holders of two-thirds of the stock in each of the constituent companies at the two meetings approved the joint agreement. Since that time no objection seems to have been made by any stockholders or by the state to the exercise by the defend ant company of its franchises as a consolidated corporation of Ohio and Michigan. It actually exercised franchises as such cor poration. It operated as such a railroad from Toledo to Lake Michigan. The holders of the 33,000 shares of the stock of the defendant company represented by petitioners or their predecessors in title appeared and voted as stockholders in the defendant company at its different annual meetings, the last of which was held in April, 1894. It may be true that the failure to give the notice required in the statute, or the failure to file the certificate of consolidation required in the statute, prevented the new consolidated company from being legally incorporated under the laws of Ohio, but it is manifest that the new consolidated company was a de facto corporation of Ohio, while, in the absence of any averment to the contrary in the petition, we may assume that it was not only a de facto, but a de jure, corporation of the state of Michigan. It is too well established to need discussion that both a de facto corporation and the persons exercising the rights of stockholders in such a corporation are estopped to assert its unauthorized existence as a corporation to avoid a debt incurred by it in the actual exercise of corporate franchises and the doing of corporate business. Ashley v. Supervisors, 8 C. C. A. 455, 60 Fed. 65; Phinizy v. Railroad Co., 62 Fed. 678; Dallas Co. v. Huidekoper, 154 U. S. 654, 14 Sup. Ct. 1190; Close v. Cemetery, 107 U. S. 466, 2 Sup. Ct. 267; Bank v. Matthews, 98 U. S. 621; — 56 — Macon Co. v. Shores, 97 U. S. 272; Chubb v. Upton, 95 U. S. 665; Douglas Co. v. Bolles, 94 U. S. 104; Wallace v. Loomis, 97 U. S. 146; Leavenworth Co. v. Barnes, 94 U. S. 70; Casey v. Galli, Id. 673. Certainly it showed no neglect of duty or bad faith on the part of any of the directors not to set up such a defense for the foreclosure of the consolidated mortgage. Second. The petition alleges as follows: “Your petitioners further respectfully show that the capital stock of said alleged consolidated railway company did not and does not exceed $6,500,000, and that the issue of mortgage bonds exceeding that amount was, under the laws of Ohio, unauthorized and void; and that the said consolidated mortgage, being for the sum of $10,000,000, and the bonds issued thereunder, together with the bonds secured by mortgage previously issued upon the so-called ‘divisions’ of said railroad, exceeding the amount of said capital stock, should be held to be unauthorized and void.” Section 3286 provides: “A company may issue bonds, convertible or otherwise, bearing a rate of interest not exceeding seven per centum per annum, to an amount not exceeding two-thirds of its capital stock, actually subscribed, for one or more --of the following purposes: completing or extending its road, constructing branch roads, laying double or additional track, increasing its machinery or rolling stock, building depots or shops, making improvements, paying its unfunded debts, or redeeming its bonds; and it may secure the bonds issued for such purposes by mortgage on its property, or otherwise, if authorized by the vote, in person or by proxy, of holders of a majority of the stock upon which all the installments ■ called for by the board of directors have been paid; but such vote shall be taken at a meeting of stockholders of which thirty days’ notice shall be given.” Section 3287 provides that: “A [railroad] company may borrow money at a rate not exceeding seven per centum per annum, for any purpose that the same may be needed in its business and execute bonds or promissory notes therefor, in sums of not less than one hundred dollars; and it may secure the payment of such bonds and notes by a pledge of its property and income; but the aggregate indebtedness authorized by this and the preceding section shall not exceed the amount of the capital stock of the company.” It appears by a reference to the minutes of the company that the capital stock, until April 16, 1890, was 53,000 shares; that upon that day, at the regular annual meeting of the stockholders, at which were represented 43,160 shares, it was resolved to increase the capital stock of the company from 53,000 shares of $100 each to 80,000 shares of $100 each; and that an amended charter was adopted by the meeting for this purpose, all the shares represented voting in the affirmative. At the .same annual meeting it was resolved that 9,000 shares of the new stock be delivered to the Toledo, Ann Arbor & Lake Michigan Railway Company as part payment for the purchase of its property and franchise, and that 15,000 shares be delivered as part payment for the Cincinnati, Saginaw & Mackinaw Railway Company, its property and franchises. The latter purchase fell through, and the stock was not delivered. Subsequently, at the annual meeting in 1892, the stockholders authorized the delivery of 5,000 shares of the company’s capital stock to the Frankfort & Southeastern Railway Company as part payment for the purchase of that company’s prop — 57 — erty and franchises. The additional stock over and above the original 53,000 shares was voted at subsequent annual meetings. The consolidated mortgage, purporting to secure $10,000,000 of bonds, is said to have been authorized at a stockholders’ meeting on January 15, 1890, but no bonds were issued under that mortgage, so as to become a binding obligation of the company, until after the annual stockholders’ meeting of April, 1890, when the increase of stock and the amended charter were adopted by the unanimous vote of all the stock represented. The number of bonds issued under the consolidated mortgage upon which a decree has been rendered is $1,443,000. This sum, taken with the underlying additional mortgages, amounts to something over $7,000,000. Section 3307 of the Revised Statutes of Ohio provides that a company may increase its capital stock whenever, in the opinion of the directors, the same is insufficient for tlie construction of its road, or it becomes necessary for the transaction of its business to construct a second track, or to buy another road within the state, or for the purpose of extending the same, or to refund its debts, or for completing its line of road. Section 3308 provides that before any stock can be issued a majority of the directors shall call a meeting of the stockholders, designating the time, place, and purpose of the meeting, and the amount of stock required, that notice shall be given at least 30 days previous by publication in two newspapers, and by a like notice, mailed 30 days previous, to each stockholder whose residence is known. And that, "if at such meeting the consent of the holders of a majority of the stock upon which they would be entitled to vote at an election of directors of the company be given, the stock of the company may be increased to such amount as may be decided necessary or requisite for the purposes named in the preceding section.” The purpose recited in the resolution adopted in this case was that of extending the line of the railroad company by purchase. Section 3310 requires that "ten days after the meeting the president and secretary of the company shall make an abstract, stating the whole amount of pre-existing capital stock, the amount authorized, the number of shares of stock upon which all the installments called for by the board of directors have been paid, and the vote at the meeting, and add a certificate that the provisions of the two preceding sections have been fully complied with; and they shall make affidavit to such abstract and statement and file the same in the office of the secretary of state, who shall cause the same to be recorded.” It may be conceded that the course actually taken was not the statutory method provided for increasing the capital stock; that it was defective in the character of the notice, which was a notice for a mere annual meeting; and also in the failure to file the proper certificate with the secretary of state, and to have the same recorded in his office. But we are of opinion that the same reasons make this defense unavailable to the petitioners which prevailed against the first one considered. The corporation in — 58 — which the petitioners are shareholders assumed the character and capacity of a corporation with 80,000 shares of stock, and, without objection from the state, acted as such, and had so acted for more than two years. It had assumed that character upon the authority of the almost unanimous vote of its shareholders, and had continued to exercise the functions incident thereto without dissent from any of them. Upon consideration of these facts it is clear that not only the corporation, but the stockholders also, are now estopped to defeat any obligations assumed by that company on the ground that its stock was not equal to 80,000 shares. Conceding that the limitation in section 3287appliesto aconsolidated company, and that such a company cannot have an aggregate indebtedness, secured by mortgage, in excess of its capital stock, the limitation, it will be observed, is not upon the amount of the mortgage, but upon the amount of the bonds issued which the mortgage secures. The fact, therefore, that the mortgage is for $10,-000,000, does not invalidate it as security for $1,443,000 of bonds issued under it. Of course, it is a' mortgage which can be enforced only to the extent of the actual obligations created under it, and, as those obligations do not exceed $1,443,000, it is only to be regarded as a mortgage for that amount. Taking it as such, with the other indebtedness, the total is less than $8,000,000, which the stockholders of the company by unanimous vote agreed should be the capital stock of the company, and under which vote a large part of the increased stock was issued and subsequently voted. Under these circumstances we do not think that the corporation can be heard to urge section 3287 as a reason for invalidating the bonds by it, and that the stockholders who acquiesced in this action for more than three years are equally estopped to make such a defence. 2 Cook, Stocks & S. § 760; Allis v. Jones, 45 Fed. 148; Reed’s Appeal, 122 Pa. St. 565, 16 Atl. 100; Fidelity Insurance, etc., Co. v. West Penn. & S. C. R. Co. (Pa. Sup.) 21 Atl. 21; Wood v. Water Works Co., 44 Fed. 146; Water Co. v. De Kay, 36 N. J. Eq. 548. We do not think that the decisions of the supreme court in Nesbit v. Riverside Independent Dist., 144 U. S. 610, 12 Sup. Ct. 746, and kindred cases, in which bonds were held invalid when issued in excess of an absolute limit fixed by statute,—as, for example, a percentage of the taxable value of property in a county,—have application to a case of this sort, where it is plainly within the power of the corporation, by properly increasing its stock, to issue bonds equal in amount to the increase, and where an increase is attempted, and the only defect is an irregularity in the method by which the increase is sought to be made; rather than in a total want of power to secure it. The third defense proposéd is that the consolidated mortgage was never authorized by the stockholders and directors at a legally called meeting. There is nothing in this defense. It rests on the absence of a record of such a meeting in the minutes of the railroad company. Ashley, one of the officers of the railroad com — 59 — pany, testifies positively that there was such a meeting, and reference is made in the subsequent minutes to such a meeting of the stockholders and of the directors. Whether the meeting was duly called in accordance with the requirements of the statute is immaterial, because the binding effect of the mortgage and the bonds have been recognized at every annual meeting since its issuance, and by the payment of interest upon the indebtedness thus represented for three years. The binding effect of the mortgage and the bonds was recognized by the petitioners themselves, when acting as a reorganisation committee. If there was any defect by reason of a want of original authority to issue the bonds and mortgage, it has been cured by subsequent ratification. Hotel Co. v. Wade, 97 U. S. 13; Supervisors v. Schenck, 5 Wall. 772; Clay Co. v. Society for Savings, 104 U. S. 587. Fourth. The next and last defense proposed to be made is that the bonds issued under the mortgage were diverted from their lawful purpose, or, rather, that there was an overissue of them beyond the limit fixed in the mortgage itself and in the bonds themselves for the purposes therein mentioned. The mortgage and the bonds, as already stated, limit the amount to he issued to §21,000 per mile of road then owned, and to §18,000 per mile of road to be constructed or acquired. The bonds issued under the consolidated mortgage to buy the Lake Michigan road and the Frankfort & Southeastern road, with the obligations assumed as part of the purchase price, exceed §30,000 per mile. The limitation in the mortgage was not a limitation upon the power of the corporation itself. It was a contract with the bondholders, affecting the extent of their security. It is true that if the only authority for the issuance of these bonds was to be found in the resolution authorizing the mortgage and the bonds, the limitation in the mortgage would be a limitation upon the power of the directors to use the bonds in the purchase of roads at a greater rate than §3.8,000 per mile. But, if both the stockholders and the directors acquiesced in the issuance of bonds, at a greater rate under this Mortgage, neither the corporation nor the directors nor the stockholders can now be heard to urge the limitation of the mortgage as a reason for defeating the obligation of bonds issued in excess of that limitation. The evidence overwhelmingly establishes that all the- stockholders knew that the bonds were being issued in such a way as that the amount paid for the newly-acquired roads exceeded a rate of $18,000 per mile. It was brought to their attention by annual reports, and the report of the petitioners themselves recommending their plan of reorganization shows conclusively that they had full knowledge upon this subject. It might be some ground for complaint on the part of persons who purchased bonds under the mortgage if those who were to share in the security were increased in number in violation of the assurance in the mortgage and the bonds. But certainly the corporation, which has taken the money or property of the bondholders with the acquiescence and the knowledge — 60 — of its stockholders, cannot be heard to urge such a limitation by way of the defense to a suit to recover on the bonds thus issued. The proof shows that all the bonds of the consolidated company were issued for value. A slight attempt is made to show that some of the bonds were disposed of by James Ashley, Jr., financial agent of the company, as collateral for his individual notes, but it has failed, and, whether it be true or not, the Validity of the consideration received by the company for the great bulk of the bonds is undisputed and indisputable. The mortgage must therefore be foreclosed, and, if any of the bonds were fraudulently issued, they may be attacked before distribution, under the express provision of the decree for sale already made. The petition is dismissed.