FLINT v. DANBURY BETHEL STREET RY. CO

It is a well established principle that railway mortgagees, in accepting their security, impliedly agree that they shall have no claim upon the current income of the company until its current debts, contracted in the ordinary course of business, have been paid. Accordingly, courts of equity have developed a rule in railroad and street railway receiverships, that if the current earnings of the road for a period of six months prior to the receivership were paid to the mortgagees at the expense of current creditors whose claims arose during the same period, then such claims are entitled to preference and the corpus of the mortgage security is chargeable, if necessary, with the restoration of the income thus improperly diverted from its primary use; and it is deemed conclusive proof of a diversion if it appears that the mortgagees have received any of the current earnings of the road within six months of the receivership while creditors, whose claims are based upon ordinary operating expenses during the same period, have not been paid. This rule applies, whether the receivership proceedings were instituted by the mortgagees, or by stockholders, or, as in the present case, by a creditor. In determining the income which should have been paid to current creditors, items in the nature of fixed charges for depreciation, maintenance and upkeep are not properly deductible from the gross earnings, since they do not constitute debts actually incurred in the ordinary operation of the road. Therefore, there was no merit to the contention of the mortgagees in the present case that they were entitled to the interest payments made to them within six months of the receivership on the theory that such payments were substantially equivalent to the proper provision for maintenance which the defendant had failed to make. Questions might arise as to whether actual expenditures for maintenance were or were not current operating expenses. Section 3717 of the General Statutes, which authorized the New York, New Haven and Hartford Railroad Company to charge to the defendant a certain proportion of the cost of constructing a bridge, did not expressly or by inference secure the railroad company by a lien displacing existing recorded mortgages.

CURTIS, J.

The receivership in this action is that over a street railway company, and is still in operation, and the appeal relates to claims arising before the appointment of a receiver and presents questions relating to allowed or disallowed preferences of such claims over the recorded liens of mortgagees. In Mersick v. Hartford W. H. Horse R. Co., 76 Conn. 11, 55 A. 664, decided in 1903, we reviewed the law relating to this subject in railroad receivership cases as decided by the United States Supreme Court before that date, assuming but not deciding that they were applicable to a street railway. We held as established law in railroad receiverships, the following propositions deduced from the cases reviewed: First: A railroad mortgagee when accepting his security, impliedly agrees that the current debts of the company contracted in the ordinary course of its business shall be paid out of current receipts before he has any claim on such income; and that when current earnings are used for the benefit of the mortgage creditors before current expenses are paid, the mortgage security is chargeable in equity with the restoration of any funds thus improperly diverted from their primary use. Second: Where there has been no diversion of the current income for the benefit of the bondholders there can be no restoration by a charge on the corpus.

In the later case of Gregg v. Metropolitan Trust Co. (1905), 197 U.S. 183, 25 Sup.Ct. 415, the court held that where there was no diversion of income whereby the mortgagees had profited, the general rule was that a claim for supplies furnished within six months before the appointment of a receiver was not entitled to precedence over a mortgage lien recorded before the contract for supplies was made, and that where an order appointing a receiver authorized him to pay debts for labor or supplies created within the six months prior to the receivership out of income, this was based on a special theory which has been developed with regard to income.

In the instant case there was no order made on the appointment of the receiver to pay any claims and none were paid by him, and therefore no question arises as to the propriety or lawfulness of such an order or payment. As appears in the statement of facts, the trial court decreed that certain claims were liens upon the corpus of the mortgaged property taking precedence of the recorded liens of the mortgagees. The mortgagees contest the lawfulness of such decree, both in general and in particular; they claim that the equitable doctrines relating to railroad receiverships developed in the United States courts are not applicable to street-railway companies. That such doctrines are applicable to street railways we think, upon principle and authority, is the sound rule and courts have so held. 23 R.C.L. p. 110, § 120, p. 112, § 121; Cambria Iron Co. v. Union Trust Co., 154 Ind. 291, 55 N.E. 745, 48 L.R.A. 41.

The mortgagees further claim that these doctrines are only applicable in railway receiverships when the mortgagees seek the appointment of a receiver, in foreclosure proceedings, or when made parties to a suit by a cross-complaint. The principle underlying these equitable rules in railway receiverships as stated in Mersick v. Hartford W. H. Horse R. Co., 76 Conn. 11, 55 A. 664, is that a railway mortgagee in accepting his security impliedly agrees that the current debts made in the ordinary course of business shall be paid from the current receipts before he has any claim upon the income, and that current income charged with such payment of current debts if diverted for the benefit of mortgagees must equitably be restored to pay current debts even from the corpus of the mortgaged property if necessary. This principle is obviously independent of whether the receivership suit is instituted by the mortgagees, or, as in the instant case, by a creditor or stockholder. Moore v. Donahoo, 133 C.C.A. 171, 217 F. 177. This claim is therefore overruled.

The trial court, upon a finding that from the current earnings of the defendant for the six months preceding the receivership, the mortgagees had received a payment of interest to the amount of $4,352.83, while current supply and labor expenses for that period in excess of that sum remained unpaid, ruled that this was an improper diversion and entitled such creditors to a restoration of that amount from the corpus of the estate for application to their claims. The mortgagees claim that this was not a diversion, because the court finds that it arrived at its conclusion of diversion without deducting from the gross earnings, for the six months, items for depreciation, maintenance and upkeep of the railway plant. In other words, the mortgagees claim that the current earnings of the defendant were not a fund to be applied to meet the current expenses until all depreciation of the road from failure to properly provide for its maintenance and upkeep was proved to have been provided for, and that the payment of interest on bonds, where such provision for maintenance has not been made, was in substance a provision for maintenance to which the bondholders were entitled. No case has been cited that upholds this claim, and we are satisfied that it is without merit. In effect it dedicates the current earnings to the mortgagees, in preference to the current supply creditors, to the extent of depreciation, which is contrary to the fundamental principle. The cases indicate that this equitable doctrine in regard to the application of current receipts to current debts relates to debts made in the ordinary course of business in the six months before the appointment of a receiver. North American Co. v. St. Louis S. F. R. Co., 288 F. 612, 632. Questions might arise as to whether payments for maintenance made in that period were not diversions, but where the mortgagors have made payments of interest to the mortgagees from current earnings for that period and left unpaid current ordinary expenses for that period, it is deemed conclusive proof of a diversion.

This equitable doctrine of preference upon the grounds above stated, has no relation to claims arising prior to the six months period. The claim of the New York, New Haven and Hartford Railroad Company matured in January, 1916, long before the beginning, on April 30th, 1917, of the six months period before the receivership. Unless that claim upon its maturity became a lien taking precedence over the mortgage liens, it does not fall within the equity of the six months claims so-called and is not entitled to a preference.

The State in authorizing, under what is now General Statutes, § 3717, the Railroad Company to build the bridge and charge a certain proportion to the defendant, made no statutory provision for a lien on the corpus of the mortgaged property to secure the railroad. It gave the railroad a right of action against the defendant, but did not by legislation or otherwise, attempt to secure the railroad by a lien displacing recorded mortgages. The Public Utilities Commission in its order for the payment of the cost of the bridge did not seek to limit the defendant's use of the bridge until payment was made of its proportionate share of the cost, and thus insure the payment to the Railroad Company; but failure to do this did not constitute the claim a lien on the corpus. There is no basis for a ruling that this claim of the railroad is a lien on the corpus of the defendant's property taking precedence over the mortgage liens, unless the court in this receivership proceeding has general authority to displace liens of mortgagees in favor of meritorious creditors. In Old Colony Trust Co. v. Medfield M. Ry. Co., 215 Mass. 156, 162, 102 N.E. 484, the court said: "By the appointment of a receiver the court is not vested with a general authority to displace vested liens on the body of the property created by contract." As we held in Mersick v. Hartford W. H. Horse R. Co., supra, such displacement of liens can only be ordered as a method of restoring to the company for current debts sums improperly diverted from the holders of such debts for the benefit of the mortgagees during the six months prior to the receivership. The judgment in this case gave the Railroad Company a lien upon the corpus of the defendant's property superior to the liens of the mortgagees because of the meritorious nature of the claim of the Railroad Company. The court, under the facts, had no authority to so displace the lien of the mortgagees, or otherwise create a preference. The Railroad Company has therefore merely a meritorious general claim against the defendant.

The claim of the Connecticut Company arises for services rendered for twelve months prior to the receivership on the Long Hill line so-called. The services rendered were essential to the operation of this line. The fact that this line was run at a loss is immaterial, the defendant was operating it as a part of its system and we must so treat it. The trial court allowed the Connecticut Company's claim as to services for the six months prior to the receivership. The mortgagees claim that under the facts found, the trial court could not legally so hold, because a provision in the contract for the services allowed the Connecticut Company to terminate the services if not paid therefor within thirty days after rendered. This provision of the contract does not establish the fact that these services were rendered in reliance upon that provision. It was evidential of that fact, but not conclusive proof of it. The trial court upon the record might reasonably have found the contrary. The trial court might reasonably have found and decreed as it did, that the claims for supplies and labor rendered by the Connecticut Company and the other supply claimants whose claims during six months prior to the receivership, were allowed as preferred, were entitled to a preference to the extent of a proportionate share in the $4,352.83 diverted for the benefit of the bondholders from the current receipts of the six months preceding the receivership. The claim of the Connecticut Company for any services rendered prior to the six months period before the receivership, was properly disallowed as a preferred claim for the reasons stated above. Such services constitute merely a general claim against the defendant. The fact that the Connecticut Company presented its claim early in the receivership and may have threatened to cease to perform services for the receiver if not paid, is immaterial. If, because of such a threat, the receiver had paid the claim, questions would have been presented not now before us. The fact that the unpaid services of the Connecticut Company were essential to the operation of the Long Hill line for a period prior to the six months before the receivership is also immaterial. The preferred claims entitled to a proportionate share in diverted current receipts are confined to claims for supplies and services rendered within six months prior to the receivership. North American Co. v. St. Louis S. F. R. Co., 288 F. 612, 632.

The mortgagees' first reason of appeal recites that "all of the items which constitute the consideration for said balance recommended as a preferred claim in favor of the Connecticut Company were not properly allowable as parts of a preferred claim." As the mortgagees in their brief and argument attacked the whole claim as an entirety, and the Connecticut Company in defense likewise so dealt with the whole claim, we do not consider that the different items of the claim require separate consideration.

The court erred in allowing the claim of the New York, New Haven and Hartford Railroad Company as a preferred claim entitled to a lien on the corpus of the mortgaged property taking precedence over the mortgage liens. The claim should have been allowed as a general claim, without preference as a charge on the net receipts of operation by the receiver, or as a lien on the corpus of the mortgaged property.

The court did not err in its allowance, and in the preference given to the claim of the Connecticut Company to the extent allowed, or to the claims of John McCarthy, Ferris Coal Company, John C. Serre, Harry McLachlan, and Bridgeport Boiler Company.

Nor did it err in denying such preference to the claim of the Connecticut Company for a period prior to six months before the receivership.