Babbitt v. Read

• Decision Date: 29 June 1916
• Docket Number: 236.
• Citation: 236 F. 42
• Parties: BABBITT v. READ et al.
• Court: U.S. Court of Appeals — Second Circuit

236 F. 42

BABBITT v. READ et al.

No. 236.

United States Court of Appeals, Second Circuit.

June 29, 1916

This case arises upon two appeals from a decree in a suit in equity brought by a trustee in bankruptcy of a Missouri corporation to collect upon stockholders' liabilities for the issuance of stock for less than par. The creditors for whose claims the trustee recovered amounted, together with allowance to counsel, costs, and the like, to more than $160,000, and a decree went for that amount against two New York stockholders, Read and Gardiner. There were excluded from the benefit of the decree, however, the bondholders under a trust mortgage containing a so-called 'no recourse' clause, and, because of that clause, these bondholders appeal from that portion of the decree which excluded them, and Read and Gardiner appeal from so much as found them liable at all. Other stockholders were joined, but the bill was dismissed as to them.

The facts, while somewhat complicated, are very fully and accurately reported in the opinion of the District Court (215 F. 395), in view of which it is unnecessary to repeat them at length here.

Charles A. Boston, of New York City, and P. Taylor Bryan, of St Louis, Mo., for appellant trustee.

Carter Ledyard & Milburn, of New York City (William F. Taylor, of counsel), for appellants Metropolitan Life Ins. Co. and others.

Charles E. Rushmore, of New York City (George N. Hamlin, of New York City, on the brief), for defendants Reed and Gardiner.

Before WARD and ROGERS, Circuit Judges, and LEARNED HAND, District judge.

LEARNED HAND, District Judge (after stating the facts as above).

The first question arises under the plaintiff's appeal and brings up the meaning and validity of the 'no recourse' clause. The plaintiff's idea that the stockholders' liability is not an obligation founded on the bonds, but only on the statute, seems to us verbal and scholastic. The statute is a necessary factor of the obligation, to be sure; but the obligation is none the less to pay the debt created by the bonds. If more words than are in article 22 of the mortgage are necessary to comprise such an obligation, we do not know where they could be found. Indeed, the only just criticism of the article is that its verbiage, by including so much, opens ground for suspicion. Such instruments frequently suffer from that defect; but the intent, though it could have been put in a few lines, is not lost in spite of the conventional redundancy of its expression. The meaning is so clear that the only question which can arise is whether it is against public policy, whether the clause extends to the bondholders as well as to the mortgage trustee, and whether the supposed deceits affect the situation.

We can see no reason for saying that such a provision is against public policy if the bondholders were properly apprised in advance, and no authority is suggested even remotely in point. The theory of such liabilities is that the capitalization of a company conveys a belief that it starts with an equal value in property. That theory may be questionable in fact; but, assuming it to be true, it has no application when the creditor knows how the stock was issued before he lends his money. This is the law of Missouri (Woolfolk v. January, 131 Mo. 620, 33 S.W. 432; Trust Co. v. McMillan, 188 Mo.at p. 567, 87 S.W 933, 107 Am.St.Rep. 335; Biggs v. Westen, 248 Mo 333, 154 S.W. 708) under which the plaintiff sues. The provision is only intended to protect against deception, and there is no apparent reason to deny the right to creditors to say in advance that they will not rely upon it. Such covenants have been held valid whenever they have been tested, so far as we have found. Brown v. Eastern Slate Co., 134 Mass. 590; Fidelity Trust Co. v. Washington, etc., Corporation (D.C.) 217 F. 601.

The business of selling corporate bonds is not obviously affected with a public interest, as are such businesses as those of common carriers. While it is true that such bonds are sold broadcast to large numbers of people, they are generally distributed originally to bankers or brokers in large blocks, and in such cases it is the custom of the latter to familiarize themselves with the mortgage and its provisions. The final purchasers are their customers, and look to, and depend upon, these distributors, and not upon the obligors. The case is not, therefore, one where the obligor deals directly with a numerous class, not accustomed to look carefully at the details of the bargain, and where the detailed provisions of the contract are submerged by the urgency of the demand. It may well be that these distributors do not pay such attention to the details as they should, yet the matter is one in which they have an interest to protect the eventual customer, and where, if they do not, they are themselves affected by the result. An investor can hardly be put in the class of those not responsible for the clear meaning of the instruments on which he buys; at least, if it is so, we have no means of knowing it, and the matter must await some legislative determination.

The plaintiff resorts, therefore, to the fact that the bonds did not incorporate the limitation, except by reference to the mortgage. Yet it has always been held that such a reference makes the provisions of the mortgage a part of the contract, as much in this case as in one where the instrument is prepared with the deliberate scrutiny of both sides. Natl. Salt Co. v. Ingraham, 122 F. 40, 58 C.C.A.

356; McClelland v. Norf. S.R. Co., 110 N.Y. 469, 18 N.E. 237, 1 L.R.A. 299, 6 Am.St.Rep. 397; McClure v. Oxford, 94 U.S. 429, 24 L.Ed. 129. It would indeed be only a fictitious protection to insist that such provisions as this should be incorporated in the bonds. The investor who would read with so much care the whole of a bond so voluminous as it would become, were all the limitations included, would be as likely to look at the mortgage, if the bond referred to the mortgage. Buying such bonds is not like taking a bill of lading from a common carrier, an everyday incident of common affairs. Those who wish in any case to read the extended text carefully have now the power to go to the printed mortgage, and are as likely to do so as though the bond itself contained all its limitations. Certainly we may not say that such a company is under a public duty against which it may not contract by sufficiently explicit language.

Finally, the plaintiff says that at least as to the Mackay bonds the defendants are estopped by their misrepresentations from setting up the 'no recourse' clause. Now, these alleged misrepresentations did not touch the existence of that clause in the mortgage; nor did they say that the stock had been issued for property worth its face, as in Downer v. Union Land Co., 113 Minn. 410, 129 N.W. 777. Such a statement would indeed have been absurd in the face of the fact that the bonds not only sold for less than par, but that the stock was given away as a bonus. They were general statements about the character of the property, its prospects, its value, and the extent of the title held by the company.

The plaintiff says that the defendants may not assert the clause because of these statements which constitute inequitable conduct. He wishes to use this misconduct by way of estoppel, and in that he fails, because estoppel never can do more than hold the utterer to the truth of his speech. If the rights of all the parties here are adjudicated upon the basis of the truth of the supposed deceits, it would not affect the stockholders' liability. They escape because they bargained to escape in advance, and no estoppel is relevant unless it comprises a statement that they had not so bargained. If they had sold the bonds on such a statement, they could not later take advantage of their exemption, but they did not. Nor did the defendants say that the stock was fully paid, though, if they had, it would not affect the covenant by which their liability as stockholders was waived. Downer v. Union Land Co., supra, is not to be so understood; the only point decided was that the covenant did not waive a liability for fraud and that an action of tort still lay. Finally, the general inequity of the defendant's conduct towards the Mackay group will not bar their assertion of a legal right in defense to the bill; they do not come into a court of equity, but are brought in. There is no rule of equity which takes from a defendant his legal defenses because his conduct has been inequitable. We therefore decline to consider the evidence of these supposed deceits or the extent to which the Mackay representatives were fully acquainted with the facts at the time they bought the bonds.

However, while the stockholders are protected against any claim upon them as stockholders by the 'no recourse' clause, that clause does not protect them as individuals, though they be stockholders, against the claims of persons who have been induced by them to buy bonds upon fraudulent statements. Yet it is only such defrauded purchasers, and not the trustee, who have the right to assert such a claim; the Mackay group may have its rights against some of the defendants, but they cannot assert them here. Such an effort was made in Slater Trust Co. v. Gardiner (C.C.) 183 F. 268, but failed. We have nothing to say as to the success or failure of such an action, if brought by the defrauded bondholders against those responsible for the utterance of the fraud. We only seek here to avoid a confusion between two separate matters: (1) The wrong done by deceit in selling the bonds; and (2) the obligation of the stockholders because of their acceptance of the stock.

This disposes of the main points in the plaintiff's appeal. The lesser points we...