Moore v. Donahoo

• Decision Date: 14 September 1914
• Docket Number: 2353.
• Citation: 217 F. 177
• Parties: MOORE et al. v. DONAHOO et al.
• Court: U.S. Court of Appeals — Ninth Circuit

217 F. 177

MOORE et al. v. DONAHOO et al.

No. 2353.

United States Court of Appeals, Ninth Circuit.

September 14, 1914

On Petition for Rehearing, November 17, 1914.

On Petition for Rehearing.

Edward J. McCutchen, Gavin McNab, and A. Crawford Greene, all of San Francisco, Cal. (McCutchen, Olney & Willard, of San Francisco, Cal., of counsel), for appellants.

Goodfellow Eells & Orrick, of San Francisco, Cal., for certain claimants.

Sullivan & Sullivan, Theo. J. Roche, and Goodfellow, Eells & Orrick all of San Francisco, Cal., for certain labor claimants.

Charles S. Cushing and Wm. S. McKnight, both of San Francisco, Cal for Remington Typewriter Co.

Frank M. Hultman, of San Francisco, Cal., for August Johnson.

Maurice R. Carey, of San Francisco, Cal., for R. P. Standley et al.

Daniel H. Know, of San Francisco, Cal., for Knox and another.

A. F. Morrison, Peter F. Dunne, and W. I. Brobeck, all of San Francisco, Cal., for Mercantile Trust Co., of San Francisco.

Before GILBERT and ROSS, Circuit Judges, and DIETRICH, District Judge.

DIETRICH District Judge.

The appellants represent the interests of the mortgagee, and the respondents are the unsecured creditors, of an insolvent railroad company. The general question involved is when and to what extent the claims of those who in the ordinary course of business furnish labor and supplies for the maintenance and operation of a railroad will, in the distribution of its assets by a court of equity, be preferred to bonds secured by a pre-existing mortgage.

The facts are presented in the form of an agreed statement, accompanied by the decree of the lower court, as provided by general equity rule 77 (198 F. xli, 115 C.C.A. xli). It is thereby shown that the Ocean Shore Railway Company was the owner of two short lines of railroad near the city of San Francisco, Cal., and on November 1, 1905, it executed a trust deed to the Mercantile Trust Company of San Francisco to secure the payment of an issue of bonds aggregating $5,000,000, the deed covering all of its property, including future acquisitions and income. Substantially all of the bonds were sold and became the valid obligations of the mortgagor. No interest having been paid on account of the installments falling due upon November 1, 1909, and May 1, 1910, the trustee, acting in pursuance of the authority conferred upon it by the provisions of the mortgage or trust deed, declared the entire principal due, and upon June 7, 1910, caused notice to be published of its intention to sell the property for the purpose of paying the indebtedness. The sale was originally set for September 1, 1910, but was postponed to October 1, 1910, and, under circumstances to be explained, was finally consummated on January 17, 1911.

In the meantime, on December 6, 1909, the Baldwin Locomotive Works, an unsecured creditor, filed a bill against the railway company as the sole defendant, in the United States District Court for the Northern District of California, in behalf of itself and of other creditors. It was shown by the bill that the defendant was indebted upon unsecured claims aggregating approximately $2,000,000, that it was insolvent, and that there was danger of its property becoming dissipated or impaired in value by the prosecution of numerous suits and the levy of attachments and executions. There was a prayer for the appointment of a receiver and for an order directing him to pay the claims of plaintiff and others out of the net operating revenues of the property. Upon the same day the railway company appeared, and by answer admitted the allegations of the bill and joined in the prayer for a receiver. One F. S. Stratton was thereupon appointed receiver, who at once took possession of the property and continued to operate it until February 1, 1911. On May 21, 1910, by supplemental bill, the Mercantile Trust Company was made a party defendant, together with numerous creditors who had intervened.

On July 22, 1910, upon the representation of the receiver that he could not operate the property without loss, the court entered an order, directed against all parties to the suit, including the trustee, requiring them to show cause why a sale should not be made by the receiver. In response thereto, the trust company, appearing 'specially,' asked that the order to show cause be discharged, and also filed a cross-bill setting forth its interest and praying that it be permitted to proceed with the sale without interference from the receiver. Hearings were had, and the court, having assumed jurisdiction to supervise and control the sale, entered an order authorizing the trust company to sell the property, under certain prescribed conditions, one of which was that out of the proceeds a specified sum should be turned over to the receiver for the payment of the expenses of the receivership and for other purposes, and another that the sale and transfer should be made subject to the payment of certain operating and maintenance claims against the railway company incurred before the appointment of the receiver, not exceeding in the aggregate $100,000, provided the court should ultimately hold that they were entitled to priority of payment over the bonds. The claims so referred to were those which the respondents now hold, but the character and amount of which had not at that time been judicially ascertained.

The sale was made in compliance with the terms of this order, and the appellants, who became the purchasers thereat, took the title subject to the conditions prescribed. It thus appears that the sale was made under the power of the trust deed, with the permission and subject to the conditions imposed by the court. In due time the trustee made return of its proceedings, and prayed for an order confirming the sale and directing the receiver to join with it in the execution of proper instruments of conveyance. Such an order was made, and conveyances were executed accordingly. Thereupon the purchasers sought and procured permission to intervene.

The question whether or not the respondents' claims should be paid in preference to the bonds was referred to a master. The master found (and the correctness of the finding is not questioned) that the claims which accrued during the period of six months immediately preceding the appointment of the receiver-- that is, from June 1, 1909, to December 6, 1909-- on account of labor done and materials furnished in the ordinary course of business, for the normal maintenance and operation of the railroad, and which it was reasonable to expect would be paid out of the current operating income, aggregated $48,571.42. It is agreed that the labor and supplies for which this indebtedness was incurred were in each instance necessary to the business of the railway company as a carrier of freight and passengers, and to the business of the public service and were necessary for the maintenance of the railroad, and to keep it a going concern. There was no current income on hand at the time the receiver was appointed, and the operation by the receiver was at a loss. Of the operating income accruing from June 1, 1909, to December 6, 1909, there was applied to the payment of expenses of construction and other obligations having no relation to the operation or maintenance of the road the aggregate sum of $30,000. There was no evidence as to the exact time when the diversion of any specific part of this sum was made.

The master held that all of the claims were preferential in character, but, adopting the 'income' theory, limited the preference to the amount of the diverted income, and hence recommended a pro rata distribution of the $30,000 to the several respondents. While confirming the master's report in other respects, the court below took the view that, inasmuch as the indebtedness due the respondents was necessarily incurred in keeping the railroad a 'going concern,' the question of diversion was not controlling, and entered a decree adjudging the entire amount of $48,571.42 to be a first lien upon the property, and required the purchasers to pay the same, together with interest. The appeal is from this decree.

Conceding that under certain circumstances and within certain limitations the claim of a general creditor of an insolvent railroad corporation may be preferred to a pre-existing mortgage lien, appellants contend that the decree should be reversed or modified for the following reasons:

(1) The preference of the respondents, if any they have, is limited to the amount of income diverted, namely, $30,000.

(2) No one of the respondents is entitled to priority, because the trustee did not commence an action of foreclosure or secure the appointment of the receiver, or, as is claimed, submit itself to the operation of the rule that he who seeks equity must do equity.

(3) There is no proof that any current income was diverted during the six months period after the indebtedness of any one of the respondents had become payable.

1. As already intimated, the general question involved in the first proposition is whether we shall give place to what is known as the 'net income' theory, or to the 'going concern' theory, as the basis for preferential allowances. Are claims, such as those of the respondents are conceded to be, for current supplies and services which are necessary to the maintenance of the property of a public service corporation, and to keep it in operation, to be paid out of the current income in preference to the bonds, upon the assumption that the lien of the mortgage attaches only to the residue of the income remaining after the payment of the operating expenses, or may they displace the vested lien of the mortgage upon the corpus of the estate, because the claimants by their labor and supplies...