383 F.2d 571 (5th Cir. 1967), 23608, Watts v. Missouri-Kansas-Texas Railroad Co.

Docket Nº:23608.
Citation:383 F.2d 571
Party Name:Edward S. WATTS et al., Appellants, v. MISSOURI-KANSAS-TEXAS RAILROAD COMPANY, Appellee.
Case Date:August 10, 1967
Court:United States Courts of Appeals, Court of Appeals for the Fifth Circuit

Page 571

383 F.2d 571 (5th Cir. 1967)

Edward S. WATTS et al., Appellants,



No. 23608.

United States Court of Appeals, Fifth Circuit.

Aug. 10, 1967

Rehearing Denied Sept. 20, 1967.

Page 572

Sidney Stahl, William Van Dercreek, Ray Besing, Geary, Brice & Lewis, Dallas, Tex., for appellants.

Monroe E. Clinton, John B. Webster, Dallas, Tex., Harry G. Silleck, Jr., Thomas W. Evans, New York City, for appellee, Nixon, Mudge, Rose, Guthrie & Alexander, New York City, of counsel.

Before GEWIN, COLEMAN, GOLDBERG, Circuit Judges.

GOLDBERG, Circuit Judge.

This is a class action brought by eight individuals and a corporation 1 (the Holders), who hold 5 1/2% Subordinated income debentures due January 1, 2033, on behalf of all other holders, against the Missouri-Kansas-Texas Railroad (Katy). 2 The Debenture is an unconditional promise to pay 5 1/2% Interest out of income as defined in Article 2 of the Indenture, dated January 1, 1958, made and entered into between the Katy and the New York Trust Company (now the Chemical Bank New York Trust

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Company) as trustee. 3 The Holders allege that the value of the outstanding debentures is $58,000,000, and that the Katy owes approximately $8,000,000 in current and accumulated unpaid interest. The Holders allege further that the Katy has realized certain gains, including gain from the sale of land ($5,634,389), from income tax refunds ($2,229,858), and from cancellation of indebtedness by the Katy's acquisition of its own debentures at less than their face value ($14,704,990), which sums should have been credited as 'available income' (a term of art defined in the Indenture; see footnote 2, supra), and used to pay the interest obligation owing on the Debentures.

The Katy's answer interposed two defenses relevant here: first, that the Holders' pleadings had failed to meet certain conditions precedent for maintaining the suit (see footnote 4, infra), and second, that the Interstate Commerce Commission, and not the district court, had primary jurisdiction of this action.

The district court granted the Katy's motion for judgment on the pleadings (F.R.Civ.P. 12(c)), and it dismissed the cause, without stating its reasons. The Holders appeal. We reverse the district court and hold that the suit may now be maintained, and that jurisdiction over it should be retained by the district court while the questions in the case which concern the Katy's accounting practices are referred to the Interstate Commerce Commission under the primary jurisdiction doctrine.

I. Standing to sue. The Katy argues that the Holders, in order to bring this action, must satisfy Section 6.06 of the Indenture, 4 which requires notice to the

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trustee, demand upon the trustee to sue by bondholders who hold 25 per cent of the aggregate principal amount of the outstanding bonds, and refusal to sue by the trustee, before the bondholders themselves can sue. With these conditions the Holders have not complied.

The Holders rely on Section 6.07 of the Indenture. 5 They argue that Section 6.07 is an exception to Section 6.06, and permits suits by individual bondholders on the 'unconditional and absolute' obligation to pay principal and interest, as they become due.

We agree with the Holders. The result is compelled by the wording and construction of the Indenture, especially in the light of the long history of cases which reach the same result.

It is common for indentures to restrict suit by bondholders unless conditions similar to those in Section 6.06 are met. These restrictions are justified where they prevent rash, precipitate, or harassing suits by bondholders who disrupt corporate affairs by seeking to reach and deal with the security underlying the bond obligations.

No such justification exists where a bondholder seeks merely to collect the interest or principal due and owing him under the bond. Courts have recognized this distinction and have limited 'no-action clauses' as the provisions setting forth the restrictions on suit are often called) so that they do not restrict suits by individual bondholders for interest or principal due and owing. In Noble v. European Mortgage and Investment Corp., 1933, 19 Del.Ch. 216, 165 A. 157, the Court had before it provisions virtually identical to those in this case. 6 The opinion states in part:

'So far as the literal language of the instrument goes, the compulsion upon

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the bondholders to act first through the trustee is confined only to remedies 'under or upon this indenture.' The complainants are not seeking to pursue any rights under the indenture. The last paragraph of the quoted except is quite clear in reserving to the bondholders complete liberty of action to enforce all payments due them whether for principal or coupons so long as the procedure they adopt is not under the indenture. Restrictions of the character found in this indenture are not to be extended by implication. They are effective only so far as they are clear and reasonably free from doubt. * * * Being restrictive of the common law rights of creditors, they are to be strictly construed. * * * The complainants hold interest coupons which are in default. Under the terms of the indenture itself they can assert with respect to such coupons the right of payment and can bring an action to enforce the same. The complainants are creditors, therefore, who possess a right to enforce immediate payment of coupons overdue without recourse to the trustee. * * * This gives them a status entirely unaffected by any supposed limitations which the indenture might be thought to impose upon their right to seek to enforce payment of the principal of the bonds.' 19 Del.Ch. at 221, 165 A. at 159.

Halle v. Van Sweringen Corp., 1936, 7 W.W.Harr. 491, 37 De. 491, 185 A. 236. See Putnam v. Pittsburgh R. Co., 1938, 330 Pa. 210, 199 A. 211; Japha v. Delaware Valley Utilities Co., 1940, 1 Terry 599, 40 Del. 599, 15 A.2d 432.

Birn v. Childs Co., Sup.Ct.1942, 37 N.Y.S.2d 689, was a suit to enforce a covenant in the indenture which required the corporation to pay certain sums into a sinking fund. The New York Supreme Court distinguished that case from cases like the present: 'This suit is one for the enforcement of a covenant of the indenture, the sinking fund provision, and is not one to enforce payment of the debentures or their coupons, and it thus falls within the scope of (the section of the indenture with requirements similar to those of Section 6.06 here).' 37 N.Y.S.2d at 696. 7 See Betts v. Massachusetts Cities Realty Co., 1939, 304 Mass. 117, 23 N.E.2d 152.

Another major reason for limitation and strict construction of no-action clauses has been the desire to keep the bond, or debenture, negotiable. This aspect of the problem is discussed in Mendelson v. Realty Mortgage Corp., 1932, 257 Mich. 442, 445, 241 N.W. 154, 155:

'The rule invoked by defendant has its limitations, 3 R.C.L. 871, which need not be discussed because it is a fact, recognized alike by business and the law, that a bond and its securing mortgage have different functions, are governed by different legal principles, and, for some purposes at least, are separate contracts. * * * If it were not so, there would be no negotiable bonds except by accident, because provisions found in practically all trust mortgages would destroy negotiability. * * * Primarily, a bond is a contract to pay; the mortgage is a separate contract to secure payment. The provisions of the mortgage are incorporated

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into the bond only in so far as, by proper language, they are made part of the bond and the holder thereby is given notice of them. * * * The incident of negotiability in bonds necessary to enable the business of the country to be transacted and the protection of the bondholder from conditions in a mortgage which he ordinarily does not see, and which are not set out in the bond which he does see, have properly inclined the courts to a struct construction of language which attempts to modify the obligation of and rights under a bond by incorporation in it, through reference, of provisions of the mortgage.'

The New York cases have taken this line. Cunningham v. Pressed Steel Car Co., 1933, 238 A.D. 624, 265 N.Y.S. 256, aff'd per curiam, 1934, 263 N.Y. 671, 189 N.E. 750; Medwin v. 11 West Forty-Second Street, Inc., 1941, 261 A.D. 721, 27 N.Y.S.2d 551; Lubin v. Pressed Steel Car Co., N.Y.City Ct.1933, 146 Misc. 462, 263 N.Y.S. 433. In Guardian Depositors Corp., v. David Stott Flour Mills, Inc., 1939, 291 Mich. 180, 188, 289 N.W. 122-123, Chief Justice Butzel discusses this problem with candor:

'I cannot agree that the reference to the clause referring the bondholder to the trust mortgage in order to ascertain the terms and conditions upon which the bonds were issued and secured is obscure or indefinite. It is inconspicuous because grouped with matters not controlling the right to sue on the bond, but it distinctly refers to the trust mortgage and the 'terms and conditions on which said bonds are issued and secured.' We have consistently held that reference in the bond to the mortgage for other conditions was sufficient. * * *

'It seems that similar wording in a bond that refers to a mortgage forbidding an action by an individual bondholder has been upheld by both State and Federal decisions in the numerically larger number of cases and jurisdictions where the question has arisen. On the other hand, such mere reference has been held insufficient by the court of New York and Illinois. The two viewpoints are irreconcilable as will be shown by the large number of decisions collated in 108 A.L.R. 88. The Federal courts and probably a numerical majority of the...

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