Atlantic Trust Co. v. Woodbridge Canal & Irrigation Co.

• Decision Date: 04 January 1897
• Citation: 79 F. 39
• Court: U.S. District Court — Northern District of California
• Parties: ATLANTIC TRUST CO. v. WOODBRIDGE CANAL & IRRIGATION CO.

79 F. 39

ATLANTIC TRUST CO. v. WOODBRIDGE CANAL & IRRIGATION CO.

United States Circuit Court, N.D. California.

January 4, 1897

J. J Scrivner and John B. Hall, for complainant.

Daniel Titus, for defendant.

Wm. M Cannon and Paul C. Morf, for petitioners for preference.

McKENNA Circuit Judge.

This is a suit to foreclose a mortgage, in which a receiver was appointed. Demurrer of complainant to petition of William Alloway, claiming preference as a laborer. The allegation of the petition is:

'That said defendant, the Woodbridge Canal & Irrigation Company on the 1st day of October, 1894, was, and is now, indebted to your petitioner in the sum of $278, for work and labor done and bestowed between the 1st day of April, 1894, and the 1st day of October, 1894, by said petitioner for said above-named defendant, in the construction, alteration, addition to, repair, and supervision of its said ditches and canals, as a laborer, and at its request.'

It is further alleged, in substance, that such sum was one of the necessary current expenses incurred by said defendant in preserving, operating, repairing, constructing, and extending the ditches, canals, and branches of defendant's works, and was essential to their conservation.

The question is, is the sum due a preferential debt? What is or is not a preferential debt, as against mortgaged railroad property, if a receiver be appointed, has received consideration in a number of cases, and certain propositions have become established. The primary principle is that the mortgage lien is paramount to subsequent charges, and, if displaced at all, it must be by a clearly superior equity. The equity, whatever its extent, is applied as part of the court's discretion of taking the control and administration of the property by a receiver. It may be a condition of appointment, or exercised afterwards. It may be applied to income or corpus, under particular circumstances. These propositions are not disputed. I mention them now to limit the inquiry to what is disputed, without the necessity of noticing the language of some of the cases which seem to make them important distinctions. It would seem from the cases that the equity depends partly upon the principle that current income, though in terms covered by the mortgage lien, is the property of the mortgagor until possession be taken by the mortgagee, and hence it may be applied to current debts, and partly upon the principle of estoppel, arising from the delay of the mortgagee after default of the mortgagor. It is not necessary to review the cases. This has been done so often by able judges that to do so again would be as affected as useless. An able summary of their general doctrine was made by Mr. Justice Harlan in Thomas v. Railway Co., 36 F. 808. The exact point in the case at bar, however, is not explicit in that summary, nor an indisputable inference from it, nor from the decisions of the supreme court. At any rate, since that time Judges Caldwell and Jenkins, in well-considered opinions, have expressed opposite views, and a reconciliation of them seems impossible. None, at least, was apparent to Judge Jenkins, for he definitely disapproved of those Judge Caldwell entertained. Judge Jenkins says that the principle which underlies the allowance of preferential claims in the case of railroad foreclosures is 'bottomed upon the idea of diversion of funds in equity belonging to the general creditors, in preference to bondholders. ' Judge Caldwell extends the principle, and includes in the claim of preference 'those which have aided to conserve the property, and have been contracted within some reasonable time'; and an essential antagonism seems to be expressed between his view and that of Judge Jenkins by the following passage: 'And it is an error to suppose that such debts can only be given priority where there has been a diversion of the income of the road. * * * ' See Farmers' Loan & Trust Co. v. Kansas City, W. & N.W.R. Co., 53 F. 182; Same v. Northern Pac. R. Co., 68 F. 36. In Trust Co. v. Riley, 16 C.C.A. 610, 70 F. 32, decided by the circuit court of appeals for the Eighth circuit, a distinction is made which brings us nearer to the case at bar. Sanborn, circuit judge, . After stating the general principle by a quotation from Fosdick v. Schall, 99 U.S. 235, he described the kind of claim passed upon in all the subsequent cases, down to and including Thomas v. Car Co., 149 U.S. 110, 13 Sup.Ct. 824, and said:

'From this brief review of the decisions of the supreme court hearing upon this question, we think these propositions may properly be deduced: First. There are certain claims against a mortgaged railroad company, accruing before the appointment of a receiver, which are entitled to a preference over a prior mortgage debt in payment out of the earnings of the railroad during the receivership, and out of the proceeds of the sale of its property. Second. It is an indispensable element of every such claim that it is founded upon property furnished or services rendered to the mortgagor, which either preserved or enhanced the value of the security of the mortgage debt, and thereby inured to the benefit of the mortgagee. Third. Claims of this character have been given a preference over the mortgage debt by these decisions on one of two grounds,-- either on the ground that the mortgage is a lien on the net, and not on the gross, income of the railway company; and where that part of the income that is applicable to the payment of current expenses of operation, proper equipment, and necessary improvements has been diverted to pay interest on the mortgage debt, or to otherwise benefit the security, and this diversion has left claims for these expenses unpaid, it is the province and duty of the chancellor to restore the diverted fund by taking an equal amount from the earnings of the railway company during the receivership, and applying it to the payment of these claims in preference to the mortgage debt (Fosdick v. Schall, 99 U.S. 235; Burnham v. Bowen, 4 Sup.Ct. 675; St. Louis, A. & T.H.R. Co. v. Cleveland, C., C., & I. Ry. Co., 8 Sup.Ct. 1011; Railroad Co. v. Hamilton, 10 Sup.Ct. 546; Morgan's L. & T.R. & S.S. Co. v. Texas Cent. Ry. Co., 11 Sup.Ct. 61), or on the ground that the payment of the claims is necessary to preserve the mortgaged railroad and to keep it a going concern.'

From this case it is clear that diversion of income is not a universal condition of preference. This is confirmed by the language of Mr. Chief Justice Fuller, speaking for the circuit court of appeals for the Fourth circuit in Finance Co. of Pennsylvania v. Charleston, C. & C.R. Co., 10 C.C.A. 323, 62 F. 205.

'It must be regarded as settled that a court of equity may make it a condition of the issue of an order for the appointment of a receiver for a railroad company that certain outstanding debts of the company shall be paid from the income that may be collected by the receiver, or from the proceed of sale that preferential payments may be directed of unpaid debts for operating expenses accrued within 90 days, and of limited amounts due to other and connecting lines of road for materials and repairs, and for unpaid ticket and freight balances, in view of the interests both of the property and of the public, that the property may be preserved and disposed of as a going concern, and the company's public duties discharged; and that such indebtedness may be given priority, notwithstanding there may have been no diversion of income, or that the order for payment was not made at the time, and as a condition, of the receiver's appointment,-- the necessity and propriety of making it depending upon the facts...